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* 


Profitable Management 


By 

J. LEE NICHOLSON, C. P. A. (N. Y.) 

Of the firm of J. Lee Nicholson and Company, Consultants 
on Organization Methods and Costs; Author 
of “Cost Accounting" 



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NEW YORK 

THE RONALD PRESS COMPANY 

1923 


HVsstJo 

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Copyright, 1923, by 
The Ronald Press Company 


All Rights Reserved 


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JUL -9 ’23 

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PREFACE 


The methods of modern business have become ex^ 
ceedingly technical and complex. But their objective is 
easy to define—it is control of the business; and control 
is wanted to insure profits. 

The more highly organized the business, the more 
likely we are to lose sight of this fact. In manufacturing, 
particularly in the highly specialized lines, problems and 
processes tend to obscure the view of the business as a 
whole. The available literature of business has a tendency 
to be departmentally intensive rather than broad. The 
methods of management are being constantly refined, but 
often they are not followed through to their ultimate use 
in making the business pay. 

The author presents this small volume in the hope that 
its very simplicity may stimulate those engaged in manage¬ 
ment to broader constructive thought and action in indi¬ 
vidual cases. 

It may be said quite frankly that the subjects dis¬ 
cussed in the book are not new. In fact, wherever the 
author found a thought well expressed by others he did 
not hesitate to quote it. Nor is the treatment extended, 
for obviously an exhaustive discussion of each of the sub¬ 
jects might fill volumes. There is no attempt to cover the 
entire field of improvement in methods, or even to make 
the book complete; dominant factors only are stressed, 
and the illustrations used are of the simplest. 

What the author does hope to contribute, however, is 
the assurance that what is said is fundamental in im¬ 
portance. It has been his good fortune in many years of 
professional work to have had intimate contact with the 


in 


IV 


PREFACE 


management problems of small businesses and large ones. 
The principles of success are no more complex in the one 
than in the other. Certain elements are vital to successful 
management. If they are lacking, the fate of the business 
depends on mere guess or chance; if they are present and 
properly co-ordinated, the business is brought under con¬ 
trol. And the result of control is profit. 

The author is indebted to Thomas Rylands, of J. Lee 
Nicholson and Company, for valued assistance in pre¬ 
paring the manuscript. He desires also to express his 
appreciation to G. C. Dent, Secretary of the Society of 
Industrial Engineers, for his searching and helpful criti¬ 
cism. 

J. Lee Nicholson. 

Los Angeles, California, 

June i, 1923. 


CONTENTS 


Chapter Page 

I Business Failures. 3 

II Organization. 6 

III Budgetary Control.22 

IV Conservation of Invested Capital. 34 

V Control of Production and of Production Cost . 39 

VI Control of Production and of Production Cost 

(Continued).59 

VII Labor .69 

VIII Uniform Cost-Finding Methods. 81 

IX Marketing the Product. 87 

X Operating Inventories. 91 

XI Mercantile Business. 100 

Appendix—Selected List of Publications. 113 


v 
































Profitable Management 








CHAPTER I 


BUSINESS FAILURES 


Large Proportion of Business Failures 

Statistics have been published, based on experience, 
showing that out of every ioo men starting out at the 
age of 25, at the end of 40 years 1 will be wealthy, 4 
will have incomes, 5 will have some earning power, 36 
will be dead, and 54 will be dependent upon relatives or 
charity for support. These statistics have to do with 
the individual, and not with business organizations, but 
the relative proportions may well be compared with busi¬ 
ness statistics along the same lines. In Administration 
for June, 1922, in an article on “Price of Progress,” this 
quotation occurred: “We could divide men into three 
classes—the superior men, comprising 12%; the aver¬ 
age 66%; and the inferior 22%.” 

Causes of Failure 

Bradstreet’s, in 1922, printed a table showing the 
causes of failures as follows: 


Incompetence . 39% 

Lack of capital. 30 

Special conditions. 11 

Inexperience . 5 

Fraud . 5 

Unwise credits. 2 

Neglect . 2 

Failure of others. 2 

Competition. 2 

Extravagance. 1 

Speculation . 1 


3 


100% 














4 


PROFITABLE MANAGEMENT 


It has been stated that of all men who enter business 
life, only io per cent actually succeed and continue in 
business. If we are to accept the table above, which 
shows that 44 per cent of the failures resulted from in¬ 
competence and inexperience, it is a fair assumption that 
a large proportion was attributable to a lack of knowl¬ 
edge respecting business methods and control. 

Causes of the lack of business success have also been 
investigated by the Federal Trade Commission. A few 
years ago the Commission reported: Of 250,000 manu¬ 
facturers in the United States, 125,000 (50 per cent) 
operated without profit; only 12,500 (5 per cent) had 
exact knowledge of the costs of their products. 

The Commission advanced the opinion that the 125,000 
businesses were operated without profit because they were 
without adequate methods for ascertaining the cost of the 
goods they produced. 

Importance of Knowledge of Methods and Control 

The complex character of modern business will not 
permit the use of inaccurate information respecting costs, 
if a satisfactory profit is to be realized. Inexact methods, 
such as “guesswork,” applying the doctrine of “chance,” 
employing “approximations,” must be eliminated from 
modern business methods. This whole situation with 
regard to the necessity for knowledge of business methods 
and control, including the all-important control of costs, 
has been well summarized by two writers, as follows: 

In regard to costs, Roger W. Babson says: 

Do not lose sight of the fact that, in the near future, concerns 
having relatively high costs will be continually in danger, because 
of the active competition of low-cost concerns. 

In regard to control, E. B. Gowin says: 


BUSINESS FAILURES 


5 


The business executive is now and will in the future be sub¬ 
jected to pressure exerted by the worker for a larger compensa¬ 
tion and by the consumer for lower prices; or, what is the same 
thing, the consumer will demand more for what he spends. 

The executive must seek the solution of this problem along two 
chief lines: (i) by improvements in production, (2) by improve¬ 
ments in distribution. 

The most intelligent, the most alert, the most resourceful manu¬ 
facturers and dealers are going to excel in these improvements and 
will build up big businesses for themselves. The less intelligent, 
less teachable, and the too conservative, will fall behind. 


CHAPTER II 


ORGANIZATION 

The Human Element All-Important 

Admitting that the solution to the problem of profit¬ 
able management under competitive conditions lies in the 
improvement of production and distribution, what are 
the resources of the executive for effecting such im¬ 
provements? The first tool at hand is organization— 
organization of production and organization of distri¬ 
bution. 

A business organization is a machine by means of 
which the forces of industry are combined and cemented 
to accomplish the purpose intended. In other words, 
it is the uniting of individuals to work together for a 
common end. The acme of success depends upon the 
proper co-ordination of many factors, the human factor 
being one of chief importance and the most difficult to 
harmonize and adjust. From top to bottom of the 
industrial mechanism, the frailties and peculiarities, the 
necessities and prejudices of the human element are con¬ 
tinually encountered, developing friction and causing 
unexpected and troublesome complexities. 

Every machine in the factory, every part of the 
product, every sale, every dollar invested, depends for 
its efficiency on man. 

Principles of Management—Business Control Not 
Personal 

Progressive business men of the present day are fully 
alive to the fact that the intensified methods under which 

6 


ORGANIZATION 


7 


business is now being conducted do not admit the possi¬ 
bility of control by the personal oversight of any single 
executive. 

Cost as Basis of Control 

Control must be largely exercised through statistics, 
which show what has been accomplished by the various 
functional divisions of the business. 

Referring to factory control, E. B. Gowin says: 

The trained mind, reasoning along the lines of control, depends 
constantly for accurate results upon statistical information. Facts, 
verifiable evidence of every operation—from the purchase of raw 
materials to the collection of bills due, have ousted “Dame 
Chance” from every progressive business establishment. The 
manager employing the best practice of today has become con¬ 
vinced that he cannot continually guess, nor can he wait for year- 
end inventories. He must exercise day-to-day control. 

B. A. Franklin says: “Cost is the basic, the funda¬ 
mental factory improvement through which the able 
executive can exercise control.” 

Control Through Understanding and Use of Possi¬ 
bilities 

How is a business to be controlled? There is only 
one answer to the question: “By accurately gauging its 
possibilities and using the possibilities as a standard of 
what ought to be done.” Control implies a knowledge 
of what is expected, and that knowledge is to be gained 
only by a thorough analysis of the principles which gov¬ 
ern successful management: 

i. A manager must have a very definite idea of what 
he is aiming to accomplish. His purpose must be 
thoroughly considered, clear, decisive, and un¬ 
affected by a habit for “doing things in the old 
way.” 


8 


PROFITABLE MANAGEMENT 


2. A manager must know how his expectations are to 

be met. This implies an accurate knowledge of 
all facilities at his command— human and mechanic 
ca l_ an d the best means for utilizing them. 

3. A manager must be able to determine and adjust 

any controllable adverse factor which may have 
prevented the realization of his expectations. 


Essential Factors 

If the three principles are closely adhered to, a man¬ 
ager may confidently rely upon effective control through 
the general departmental organization, standard accom¬ 
plishment by the operating departmental organization, 
and the operation of a budget applicable to the busi¬ 
ness as a whole. 

In putting the foregoing principles into practice, cer¬ 
tain factors are dealt with, among them are the per¬ 
sonnel, the executive himself, and the problems of 
co-ordination both of factory and of marketing activities. 

Duties of Personnel—Neither Too Broad Nor Toe 
Narrow 

As part of a business organization, each department 
head should show the right spirit of loyalty, and he should 
have a correct understanding of the extent of his duties 
and responsibilities. 

Josiah Royce says: 

A man is loyal when, first, he has some cause to which he is 
loyal; when, second, he willingly and thoroughly devotes himself 
to this cause; and when, thirdly, he expresses his devotion in some 
sustained and practical way, by acting steadily in the service of 
his cause. 

The questions of “extent of duties” and “responsi¬ 
bility” are perhaps the most important factors in assure 
ing business success. The following analysis of the 


ORGANIZATION 


9 


subjects sustains the point: It is easy to tell a man that 
he has all the latitude he needs, leaving him to judge as 
to how little he may do and how far he may go, which 
practically means a cloudy conception of his duties and 
responsibility. 

Two conditions require consideration in dealing with 
the subject: 

i. Insuffi:ient latitude. When insufficient latitude 
exists, its tendency is to cramp the mind. The individual 
at first chafes under it, and finally loses his sense of 
responsibility and does not care. 

2. If unlimited latitude is given, the individual is liable 
to go to extremes, overstep the bounds of prudence, and 
make serious mistakes, all of which materially affect his 
future efficiency. Determination of individual latitude 
should be a subject for individual treatment. Individual 
duties should be clearly defined in written instructions, in 
order that improprieties may not be open to excuse on 
the ground of ignorance as to responsibility. 

Executives as Specialists—Central Control with 
Chief Executive 

Full development of functional arrangement in a busi¬ 
ness depends on the manner of dealing with the personnel, 
and of securing unity of purpose and effort throughout 
the organization. 

Modern business methods are the result of highly 
intensified effort, requiring a functional arrangement of 
organization which is based upon an expectancy of the 
best attainable results being realized by treating each 
executive as a specialist, and placing him in control of 
the duties embraced by his specialty. In this manner 
finance, purchasing, production, and marketing the prod¬ 
uct would be specialties severally requiring the exclusive 


10 


PROFITABLE MANAGEMENT 


attention of a single executive—a specialist—the general 
administration of the business being lodged in a central 
authority—himself a specialist but a specialist in manage¬ 
ment—whose duties extend to the business as a whole. 

The chief executive is in constant contact with the 
range of duties and the achievements of each subordinate 
in the organization. He is therefore in a position to 
control the factor of personnel effectively. 

If the personnel is properly developed, much will have 
been accomplished in the direction of unifying the pur¬ 
poses and efforts of the members of a business organiza¬ 
tion. Unity of purpose and effort will in turn insure 
a proper degree of co-operation between the members 
of the organization, thereby developing efficiency within 
the limits of each department, and in interdepartmental 
relations. 

Co-ordination—More than Mere Routine and System 

In many businesses there is a complete lack of or¬ 
ganization, which prevents the realization of the state of 
efficiency imperatively required as a condition for suc¬ 
cessful modern business management. “Routine’' and 
“system” are generally employed to a greater or lesser 
extent, but these very necessary aids to efficiency of 
organization do not of themselves produce the state of 
efficiency required unless they thoroughly regulate every 
part of the organization in a manner which will “get the 
best possible results with the least possible expense,” that 
is, with the greatest degree of efficiency. 

Correct Inter-relation of Departments 

The planning of an efficient organization requires an 
intimate knowledge of the various departmental divisions 
which are natural to the business. Many of the de- 


ORGANIZATION 


ii 


partments do not turn out a tangible product, the question 
of efficiency is therefore determinable only after con¬ 
sidering the manner in which each such department has 
contributed to the general result. 

A department is to be regarded as being bounded by 
definite lines, enclosing the activities for which the de¬ 
partment is held responsible, but departmentizing a busi¬ 
ness does not wholly consist of providing the extent and 
limitations of what is to be done by each department. 
While it is very necessary to define the service which 
each department is to render, it is equally necessary to 
provide a correct correlation, or balance, between depart¬ 
ments. No single department is absolutely independent 
of the others and the organization of each department 
must provide for correct balancing with the departments 
which depend upon it for uninterrupted continuity of 
work. 

The inter-relation of the principal departments for an 
ordinary manufacturing business is somewhat as follows: 

1. The sales department must be supported by the pro¬ 

duction department. 

2. The production department must be supported by the 

purchasing department, and by the factory operat¬ 
ing departments. 

3. All departments must be supported by the general 

executive and financial departments. 

The importance of an accurate correlation of depart¬ 
ments is most strikingly exhibited by the interdependence 
of the factory operating departments. 

For instance, when the product passes through several 
operating departments before completion, each depart¬ 
ment must be so organized, with respect to personnel and 
mechanical equipment, that it will be able to deal effec¬ 
tively with the product received from the preceding de- 


12 


PROFITABLE MANAGEMENT 


partment, continue the fabricating process, and forward 
the product to the ensuing department on a definite sched¬ 
ule, thus insuring a continuous movement of work from 
one department to another, correctly timed and in the 
necessary quantity. When this is done, an even balance 
will be maintained between the operating departments, 
and the facilities of each one will be used to the best 
advantage. 

While departmentization is indisputably necessary as 
a factor in organization, sight must not be lost of the fact 
that overdepartmentization is possible. When this con¬ 
dition exists, it usually results in more or less duplication 
of clerical work, and unwarranted department expense. 

Each Department Head an Executive 

The term “executive” is to be understood as applying 
not only to the chief executive, but also to the head of a 
department. 

While the term “executive” is generally understood 
as applying to the head of an organization, each depart¬ 
ment head is the executive of his department, whether he 
has one hundred employees or three employees under him. 
The cost accountant—especially—is an executive, for if 
he has the right feeling of responsibility, a proper con¬ 
ception of his range of activity, and the necessary mental 
caliber, he will originate, suggest, and supervise the car¬ 
rying out of plans for increasing the effectiveness not 
only of his own department, but of the departments of 
the factory as well. 

Chief Executive—Relations with Staff 

No plans, however well thought out and designed, can 
be successful without the support both of the general 
executive and of his associates. One of the most impor- 


ORGANIZATION 


13 


tant factors in promoting efficiency and success, in any 
business, is the relation between the general executive 
and the various heads of the departments of the business. 
The business will be benefited in direct proportion to the 
sympathetic co-operation which exists between them. 
While the chief executive may consider that his rela¬ 
tions with the members of his staff leave nothing to be 
desired, he may be mistaken. When a condition exists 
under which the staff, as a whole, feels that its relation¬ 
ship with the chief executive is not what it should be, 
the business is in a bad way. Something must be done to 
bring the executive and his staff into the state of com¬ 
plete accord which is absolutely essential to a sympathetic 
organization. 

It is now a generally recognized fact that the era of 
“one-man” business is over; the best results are only 
accomplished by a number of men working for a common 
end, rather than any one man seeking to be the whole 
business, with his staff mere vassals. 

The general executive of a business who attempts to 
carry in his mind the vast amount of details connected 
with all departments of the business unfits himself for 
properly attending to those things which an executive 
should do. He does not profit by the valuable assistance 
which should be rendered by his staff. 

Right Quality of Support 

The general executive of an organization should be a 
leader, thoroughly familiar with the principal elements 
of his business. 

He should be guided in all his actions by the best that 
can be known. He should be supported by carefully 
selected men of ability as heads of departments, men who 
are animated by his ideals and with the determination to 


14 


PROFITABLE MANAGEMENT 


follow out his policies honestly and loyally. If these 
essentials are fully developed, the chief executive may 
rely upon a quality of support from his staff which will 
carry his projects and policies to a successful end. 

Importance of Human Factor Illustrated 

Mr. Phil. M. Conley in an article in the Industrial 
Magazine, February, 1923, hits the nail squarely on the 
head in his brief discussion of the importance of giving 
sufficient executive attention to the human factor in in¬ 
dustry. As he presents the matter the “two factors in 
industry” consist, first, of material factor, plant, equip¬ 
ment, cash, and, second, of the human factor, men, women, 
children—the vast army of workers. 

Says Mr. Conley: 

The human factor, the great army of men, women and children 
who toil year after year with the material factor, has been dealt 
with—to a large extent—by ignorant foremen and others who have 
not understood the art of handling people. Illustrations of this 
fact may be observed on every hand. I was sitting in the office 
of a plant manager recently when one of his subordinate execu¬ 
tives came in. He said: “Mr. Jones, that new motor we have just 
installed is out of order. I wish you would take a look at it.” 

“Sure,” replied the manager, “Just step into the chief engineer’s 
office and tell him to call for me in thirty minutes.” 

This was a case of a machine requiring attention, and 
the manager promptly arranged to investigate. 

Mr. Conley continues: 

Within fifteen minutes after my friend promised to look at the 
motor, his secretary opened the door and told him a workman 
wanted to see him. 

“What does he want?” asked the manager in an irritated tone. 

“I think he wants to discuss a mistake in his pay,” said the 
secretary. “But he insists on seeing you.” “Tell him to go to the 
pay-roll clerk,” said the manager. “I haven’t time to listen to 
every complaint those fellows think they have. I wouldn’t get 


ORGANIZATION 


15 


anything else done if I stopped every time some peeved workman 
wanted to see me.” 

This case differed from the motor, but the manager 
was mistaken in supposing that the needed adjustment 
was not equally important. The curt refusal to give his 
personal attention to the matter probably embittered the 
workman. 

Contrast this case with the following instance of a 
manager’s conception of the importance of dealing con¬ 
siderately with the “human factor.” The latter also came 
under Mr. Conley’s observation while talking to a manager 
of a Louisville plant: 

While we were talking a workman opened the door, hesitated 
a moment, and my friend asked him to come in. After he had 
been formally introduced, the workman asked some questions and 
left. The manager then gave the following explanation: 

“My door stands open for the members of my family. All my 
employes consider themselves members of my family. I would 
give any man a thousand dollars who could induce that workman 
to leave my employ for ten dollars more on the week. He has 
been with me twenty years. He thinks as much about this con¬ 
cern as I do.” 

In this case the manager knew the value of the human 
factor. In fact he had built up a “family spirit.” The 
enormous value of such work goes far towards success¬ 
fully handling the biggest job an executive encounters in 
the industrial field—the handling of employees. 

Element of Executive Policy Co-ordinated 

The object of a business organization is to develop 
profitable results to the fullest possible extent by bringing 
to bear the highest form of specialized individual effort, 
and the greatest degree of allied effort on the part of its 
members. Departmentizing a business is a step in organ¬ 
ization, which has for its object the securing of the best 


i6 


PROFITABLE MANAGEMENT 


possible results by centering the management of a depart¬ 
ment upon an individual, a specialist in the work of the 
department. Specialized individual effort, however, can¬ 
not accomplish the full object of organization. Inter¬ 
departmental relations are inevitable to some extent; 
correct organization, therefore, requires allied or collec¬ 
tive action by department specialists, in the interests of 
the business as a whole. 

Functionalization 

Modern organization methods take into consideration 
the advantages expected to accrue from an expansion of 
the departmental effort so as to embrace within the duties 
of a given department such functions as may be common 
to more than one department. 

In all large businesses there are certain particular 
functions of precisely the same nature, to be found in all 
or several of the departments into which the business is 
divided. Some of the most common examples are: 

1. Upkeep and installation of buildings and mechanical 

equipment. 

2. Employment and discharge of operatives. 

3. Taking the time of workers. 

4. Planning and routing. 

The four functions enumerated above are very widely 
recognized in business organization as being proper sub¬ 
jects for functional management, that is, each subject 
should be placed under the management of a single depart¬ 
ment which should control it, irrespective of the number 
of separately organized departments in which the subject 
exists. 

To put the matter in a simple form, consider function 
1 referred to above: 


ORGANIZATION 


17 


(a) Departments A, B, C, and D are operating depart¬ 

ments of a plant. 

(b) Each department is under separate management. 

(c) Separate buildings and mechanical equipment are 

used by each department. 

Functional management requires that the upkeep and 
installation of buildings and mechanical equipment, for all 
departments, be placed under the supervision of a special 
(functional) department, managed by a person skilled in 
the class of service required. The individual managers of 
departments A, B, C, and D would be relieved of any 
necessity for giving their time to matters which would 
ordinarily be quite foreign to their immediate departmental 
duties. It is quite obvious that functional management, 
along the above-stated lines, is a most important factor in 
the development of an organization. 

At the same time there should be a sharp line of 
demarcation between functional management and control 
by department managers. Functional management should 
not be employed in cases where it would tend seriously to 
impair departmental co-ordination and control. 

If organization and functionalization are properly 
carried out, profits will most certainly be increased, 
because: 

1. The personnel of the management will be actuated by 

a single purpose—the best interests of the busi¬ 
ness—operating as a unit. 

2. Unity of purpose and co-ordinated action provide a 

basis for estimating future possibilities, as a stand¬ 
ard for current performance. 

3. The various executives will promptly receive infor¬ 

mation respecting the departmental progress for 
which they are individually responsible. 

4. Executive responsibility will insure prompt action 

when deficiencies require correction. 


i8 


PROFITABLE MANAGEMENT 


Organization as Regards the Market—Research 

The foregoing remarks particularly apply to the in¬ 
ternal organization of a business. It must be stated, how¬ 
ever, that complete organization of a business requires 
organization of distribution facilities, as well as organiza¬ 
tion of production facilities. This brings up the question 
of research work. 

Manufacturers and merchants the world over have 
always recognized the necessity for some form of research 
work, particularly in connection with the requirements of 
markets. For a long time, however, they were uncon¬ 
scious of the great advantages which follow a systematic 
development of the subject. The requirements of a modern 
business now include research conducted upon systematic 
lines as applied to the necessities of every department. 

The object of systematic business research is to inves¬ 
tigate commercial conditions, for the purpose of securing 
data which will assist in the formulation of correct busi¬ 
ness policies. 

Gathering and properly utilizing statistical details is a 
very important part of the work; the direction and extent 
of the research, however, is often determined by the 
necessity for discovering the existence of conditions which 
statistics do not explain. For example, if sales statistics 
showed a steady decline in the volume of sales for all 
territories, or for special territories, the reasons for the 
decline would be a subject for research. If a new product 
were to be marketed, the general lines upon which selling 
should be done would be clearly indicated by careful 
research covering the market conditions. 

The work of the research department of a manufactur¬ 
ing business should extend to each department of the busi¬ 
ness, locating and investigating weak spots, and determin¬ 
ing the remedies which should be applied. 


ORGANIZATION 


19 


Shortly stated, systematic research should accumulate 
information which will enable the management to deter¬ 
mine the correct policies to be pursued. 

Trade Association Research 

An increasing necessity for co-operation by business 
men, in dealing with the growing complexities of business, 
have found practical expression in the formation of trade 
associations. The object of such associations is to gather 
information for the use of members, which would probably 
be gathered individually in case the associations did not 
exist. 

Research as Applied to Markets and Competition 

The sales policy of a business naturally affects all other 
departments of the business to a very vital extent. The 
purchasing, manufacturing, and financial departments are 
largely reflexes of the sales department. Research work 
for developing sales is probably the most important sort 
of research required in any business. 

Wide Field of Market Research 

It is not conceivable that a satisfactory sales policy is 
possible without a clear comprehension of market con¬ 
ditions, which must be understood to embrace conditions 
altogether outside the usual questions of demand and 
supply. Market research must go farther; it should inves¬ 
tigate such subjects as: 

j Volume of the demand under periodic conditions. 

2. Points at which the demand centers. 

3. The manner in which the demand is met. 

4. The most approved manner for packing and shipping 

the goods or commodities. 


20 


PROFITABLE MANAGEMENT 


If research provides reliable statistics upon the fore¬ 
going lines, a sales organization is in a position properly 
to direct the efforts of its various branches and agencies to 
secure a satisfactory territorial quota of sales. Under 
these conditions a sales policy could be firmly based upon 
demand for products and the territories requiring them. 

Research work—largely of the kind above referred to 
—is undertaken by consuls in the employ of governments 
seeking to develop international commerce. Exporters and 
importers may obtain valuable information from their 
government’s consular service, respecting the requirements 
of foreign markets. 

Competition—Lines of Research 

Competition is one of the industrial “spurs” which 
require particular attention. In the case of a successful 
organization a quoted price is the expression of many 
conditions which have been carefully considered. 

Business organizations guided by a knowledge of com¬ 
petitive conditions have a great advantage over organiza¬ 
tions which operate without such knowledge. The status 
of competition is shown by data respecting the following 
elements: 

1. Competitors—their names, where located, commer¬ 

cial standing, capacity of plant or business. 

2. Methods of competitors—in advertising, selling, and 

distributing their products; the class of service 
they give. 

3. Competitors’ advantages or disadvantages—with re¬ 

spect to location for obtaining raw materials, labor, 
and shipping finished product. 

Analysis, upon the foregoing lines, of markets and 
competition is invaluable from the standpoint of organiza- 


ORGANIZATION 


21 


tion management; in fact, it is one of the pressing require¬ 
ments of present-day business. 

Summary 

The following is a brief summary of the foregoing 
outline of a structure for a modern business organization: 

1. Need of recognition of the human element in manage¬ 

ment. 

2. Clear grasp of the principles of management. 

3. The personnel. 

4. Co-ordination — departmentalization — functionaliza¬ 

tion. 

5. Organization of distribution facilities (markets) as 

well as production facilities (the factory). 

Much of the data collected by research work is useful 
in planning a budget system. The manner in which a 
budget operates as a factor of administrative control is 
outlined in the next chapter. 


CHAPTER III 


BUDGETARY CONTROL 

Essential Features of a Budget 

Efficient administration of modern business depends, 
to a very great extent, upon a careful planning of its 
operations in advance, that is, establishing estimates of 
expected performance and results by means of a budget. 
The essential features of a budget, and of the control 
which it provides, are the following: 

1. A definite mark is set for accomplishment. This pro¬ 

vides an objective to which the full force of the 
organization is directed. 

2. The affairs of each department of the business are 

harmonized and properly balanced, one with the 
other, to the advantage of the business as a whole. 

3. Probabilities respecting future conditions are to be 

considered, and the business is to be adjusted to 
meet such conditions. 

The Philosophy of Budget Procedure 

It will not be seriously contested that the service which 
should be rendered by budgetary control is absolutely 
indispensable to efficient administration. Without such 
control, administration is dependent for guidance upon 
day-to-day occurrences. 

The following brief explanation of budgetary methods 
will suffice for outlining the procedure to be followed: 

1. The budget covers a definite future period—part of 

a year, or a year. 

2. Each department prepares an estimate of what it ex- 


22 


BUDGETARY CONTROL 


23 


pects to accomplish during the period of the 
budget. 

3. Before the complete budget is put in force, the depart¬ 
mental estimates are adjusted, one to the other, in 
order that the departments may work in unison. 

4. Failure of any department to accomplish its budgeted 
expectations is made the subject of rigid investiga¬ 
tion. 

By reason of the fact that the activities of each depart¬ 
ment of a business are practically governed by the sales, a 
forecast of what the sales department expects to accom¬ 
plish, during the period of the budget, furnishes the basis 
to which all other departments must be adjusted. This 
adjusting or co-ordinating of departments in advance, for 
the purpose of successfully dealing with expectations, is 
the prime object of budgetary control. The philosophy 
upon which the subject is based will be clearly perceived 
by consideration of the following: 

1. The sales department estimates the sales it expects 
to make during the period of the budget, for each line of 
product. The estimates will, of necessity, require a very 
close contact between the department and the various 
facilities of the sales organization—mail order, salesmen, 
agencies, etc. A ‘"mark” for accomplishment would be 
set for each selling facility. 

2. The purchasing and production departments are 
required to prepare detailed estimates showing how the 
volume of product for the estimated sales was to be pro¬ 
vided for. 

3. The stores department is required to show the 
adequacy or inadequacy of its facilities for properly deal¬ 
ing with stocks of raw materials and finished product 
covered by the program of the purchasing and production 
departments. 


24 


PROFITABLE MANAGEMENT 


4. Heads of departments are required to prepare esti¬ 
mates of the expenditures to be incurred for their respec¬ 
tive departments during the budget period. 

5. The financial department is required to prepare . 
estimates of receipts and expenditures for the budget 
period, showing how the expenditures were to be met. 

If it is found quite practicable to carry out the details 
of the budget, it may be put into effect and each official 
held to an accountability for due performance of his share 
in the program. 

Each department of the business is thus brought into 
complete correlation with other departments for the pur¬ 
pose of accomplishing the budget program. 

On the other hand, if it is deemed to be impracticable 
to carry out the details of the budget, by reason of in¬ 
adequacy of facilities which cannot be brought into com¬ 
plete correlation with the requirements of the program or 
by reason of inability to finance the program, the budget 
may be reduced—department by department—to the point 
at which its successful accomplishment can be amply pro¬ 
vided for. 

It will be apparent that a properly prepared budget 
will enable a forecast of profits to be made, as the ultimate 
“goal” or “mark” to be striven for by the organization. 

Budgetary control of a business is a recent develop¬ 
ment, the outgrowth of the constant strife to achieve better 
returns for invested capital. The object of the control is 
to determine the capabilities of a business in advance, and 
to hold each unit of the organization responsible for due 
performance of the estimated capability. 

Illustration of a Sales Budget 

The “grip on a business” exercised by budgetary con¬ 
trol is illustrated by the following statements representing 


BUDGETARY CONTROL 


25 


the budgeted operations of two of the most important 
departments of a manufacturing business—the sales de¬ 
partment and the production department. From the 
examples a clear conception may be obtained of the co¬ 
ordination of departments which a properly planned 
budgetary control will effect. 


Sales Budget 

For the 6 months from January 1 to June 30, 19— 

PRODUCTS 


Month ABODE Estimated 

Sales 


January.. $555.000 $217,500 $438,080 $225,000 $74,000 $1,509,580 

February. 225,000 290,000 370,000 187,500 37.000 1,109,500 

March... 375.000 253,750 444,000 112,500 74.000 1,259,250 

April. 600,000 181,250 259,000 75.000 111,000 1,226,250 

May. 75.000 435,000 222,000 225,000 148,000 1,105,000 

June. 75.000 217,500 153.920 187,500 222,000 855,920 


Totals.$1,905,000 $1,595,000 $1,887,000 $1,012,500 $666,000 $7,065,500 


The foregoing budget would be prepared by the head 
of the sales organization, from his personal knowledge of 
the conditions of the market, current and prospective, and 
after consultation with all subordinates who are charged 
with the duty of carrying out the program. The budget 
should be a summary of what each unit of the sales organ¬ 
ization may reasonably be expected to accomplish. There¬ 
fore the several detailed statements for individual and 
territorial results should be filed in support of the sum¬ 
mary, so that failure to reach the budgeted amount may 
be traced and investigated. 

The Sales Budget as a Forecast 

Bearing in mind that the sales budget is the forecast 
to which all other divisions of the business must adjust 




















26 


PROFITABLE MANAGEMENT 


themselves, the greatest possible care should be exercised 
in preparing the forecast. 

A modern sales organization, for a business of con¬ 
siderable magnitude, employs a multitude of devices for 
getting business; the probable results to be forecast must 
therefore be arrived at after carefully considering each 
selling facility employed by the organization, and the 
market conditions affecting each product. The following, 
for instance, would enter into the forecast, probabilities 
being based upon past experience, current conditions, and 
the conditions expected to be operative during the future 
part of the budgeted period: 

1. Sales expected from mail orders. 

2. Sales expected to be made by each salesman directly 

employed by the organization. 

Salesmen should be familiar with the market and 
territorial conditions which they will encounter in carry¬ 
ing out the sales policy. Therefore each salesman should 
be consulted and a sales quota allotted to him. 

3. Sales expected to be made by each branch or agency, 

the conditions upon which the forecasts are based 

being: 

(a) On the part of the head of the sales organiza¬ 

tion consultation with the respective man¬ 
agers of the branch and agency selling 
forces, with the view of setting a quota to 
be done by each. 

(b) On the part of managers of branches and 

agencies, distribution of their respective 
quotas to each selling unit in their ser¬ 
vice. 

4. The amount of stock required for head office mail 

order purposes, and the amounts required by 

branches and agencies. 


BUDGETARY CONTROL 


27 


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28 


PROFITABLE MANAGEMENT 


It frequently happens that the amounts of stock to be 
carried vary considerably during the period of a budget. 
This is a condition which particularly concerns the budget 
to be prepared by the production department. Therefore 
the sales budget must carefully indicate the amounts of 
stock and periods during which the stocks are to be main¬ 
tained. 

Illustration of a Sales Expense Budget 

The budget of sales expenses should be prepared by 
the head of the sales organization, from carefully con¬ 
sidered details of the expenses expected to be incurred for 
each classification, in respect of each selling unit. The 
details should be filed in support of the budget, so that 
any considerable excess of expenditure over any of the 
budgeted classifications may be traced and investigated. 

It is, of course, apparent that any considerable differ¬ 
ence between the budgeted and actual volume of sales will 
affect the budgeted expenses (commissions, for instance) 
which are based upon sales. 

Illustration of a Purchasing Budget 

Assume the following details to cover the estimated 
manufacturing cost of the products budgeted for sale: 


Units 

Products 

Materials 

Labor 

Overhead 

Total 

635.000 

A 

$635,000 

$622,300 

$12,700 

$1,270,000 

275,000 

B 

825,000 

266,750 

8,250 

1,100,000 

1,020,000 

C 

408,000 

836,400 

30,600 

1,275,000 

225,000 

D 

337,500 

330,750 

6,750 

675,000 

600,000 

E 

300,000 

145,000 

5,000 

450,000 



$2,505,500 

$2,201,200 

$63,300 

$ 4 . 77 o,ooo 


Assuming that the inventories at commencement and 
the inventories considered to be necessary at the end of 














BUDGETARY CONTROL 


29 


the period practically offset each other, the respective 
budgets of the purchasing and production departments 
would show the manner in which the requirements of the 
sales budget were to be met, so far as the costs of manu¬ 
facture are concerned. 

Market conditions for each class of material required 
might decide the best purchasing program to be as follows : 


Purchasing Budget 

For the 6 months from January to June 30, 19— 


19— 

Month 


Invoice Cost of Purchases 


< 

Total 

For A 

For B 

For C 

For D 

For E 

January.. . . 

.$350,000 

$200,000 

$100,000 

$75,ooo 

$50,000 

$775,000 

February... 


150,000 

100,000 

50,000 

25,000 

325,000 

March. 

. 260,000 

130,000 

100,000 

50,000 

50,000 

590,000 

April. 


100,000 

75 .ooo 

25,000 

30,000 

230,000 

May. 

. 25,000 

200,000 

.. • 

60,000 

70,000 

355,000 

June. 


45.000 

33.000 

77 , 5 oo 

75,ooo 

230,500 

Totals. . . 

.$635,000 

$825,000 

$408,000 

$ 337,500 

$300,000 

$2,505,500 

The 

financial 

commitments 

involved 

in the 

above- 


stated budget are assumed to have been shown by the 
financial budget to be practicable of accomplishment. If 
the financial budget, however, showed that the purchases 
of materials for product A required revision, in order 
that financial strain might be lessened for the months of 
January and March, any advantage to accrue from the 
heavy purchases during those months might have to be 
foregone, and the purchases distributed on the basis of 
time requirements. 

A purchasing expense budget would also be pre¬ 
pared by the purchasing department, covering the six 
months of the budget period. The object of the expense 
budget and the principles to be followed in its preparation 
are precisely the same as those which apply to the exempli¬ 
fied sales expense budget. 




















30 


PROFITABLE MANAGEMENT 


The purchasing department is an indirect (non-pro¬ 
ductive) factory department. The budgeted expenses of 
the department would therefore be included in the over¬ 
head cost, shown on the statement of estimated cost of 
manufacturing the products budgeted for sale. 

Illustration of a Production Budget 

Production Budget 

For the 6 months from January i to June 30, 19— 

UNITS OF PRODUCTS 


Month ABODE 


January.... 185,000 40,000 250,000 50,000 70,000 

February... 75,000 60,000 250,000 50,000 90,000 

March. 125,000 50,000 200,000 25,000 40,000 

April. 200,000 50,000 200,000 15,000 60,000 

May. 25,000 60,000 50,000 50,000 150,000 

June. 25,000 15,000 70,000 35,000 190,000 


Totals... 635,000 275,000 1,020,000 225,000 600,000 


The production budget would, of course, be affected 
by the inventory of each product on hand at the com¬ 
mencement of the period, and the inventories required at 
the end of the period. 

In the given exemplification the inventories are 
assumed practically to offset each other, so that the pro¬ 
duction to be turned out is the number of units required 
to meet the sales budget. 

The production budget is built up from a careful study 
of the capabilities of the plant and equipment to perform 
the estimated task, planned to meet the estimated sales. 

A production expense budget would also be prepared 
by the pi oduction department, the principles and purpose 
being identical with the expense budgets previously re¬ 
ferred to. 














BUDGETARY CONTROL 


3i 


The expenses of the department would enter into the 
overhead costs. 

Co-ordination of Budgets 

A thoroughly practicable budget is possible only if the 
most careful methods are exercised for ascertaining the 
feasibility of each department carrying out its share of the 
program. For example, referring to the exemplifications, 
the vital importance of co-ordinated departments is shown 
by the following: 

1. The sales budget is the starting point, prepared from 
carefully considered details of the sales expected to be 
made by each unit of the selling organization. The details 
are held for any investigation which may be necessary, in 
the event that the budget is not approximately realized. 

2. The purchasing budget is worked out with two 
principal considerations in mind: 

(a) The class of materials, and dates when required, 

to meet the budgeted sales. 

(b) Purchasing the materials to the best possible ad¬ 

vantage with respect to quality, price, and de¬ 
liveries. 

3. By comparing the estimated requirements of the 
sales budget, the details of estimated factory costs of the 
products, the purchasing budget, and the production 
budget, there is the following apparent co-ordination of 
the departments: 

(a) The purchasing department sees its way clear to 

obtain the various raw materials in quantities and 
at the times required for the production of the 
estimated sales. 

(b) The production department sees its way clear (if 

the purchasing program is duly carried out) to 
turn out the units of each product required for 
the estimated sales. 


32 


PROFITABLE MANAGEMENT 


By way of example, the following may be traced 
through the exemplifications with respect to product A: 

Total estimated sales of product A... .$1,905,000 


Total estimated factory cost. 1,270,000 

Gross profit ( 33 %%) .$_ 63 5,000 

Estimated cost of materials. 5 °% 


Estimated labor and overhead costs.... 50% 

On the foregoing basis, the units of product covered 
by the sales budget would be: 


January. $555,000 33 %%~ 50 % 185,000 units 

February. 225,000 33B5 -50 75 , 000 

March. 375 , 000 33 % “ 5 ° 125,000 

April. 600,000 33 % -50 200,000 

May. 75,ooo 33^ -50 25,000 ” 

June. 75,ooo 33 % -50 25,000 ” 


$1,905,000 635,000 units 


The number of units required each month and ac¬ 
counted for on the production budget and the purchasing 
budget shows that materials are provided for in January 
which will meet the requirements well into March, and 
that purchases in March will meet requirements up to the 
end of May, the purchases in May being for production in 
June. 

After budgets have been prepared by the other depart¬ 
ments of the business, the financial department is in a 
position to prepare the financial budget of the business, 
which—after final acceptance—provides a basis for pre¬ 
paring the estimated profit and loss statement and balance 
sheet. 

Emphasis must be placed upon the necessity for a 
complete balancing of the various departments, so that 
each department shall contribute the service expected for 
successfully operating the budget. 


















BUDGETARY CONTROL 


33 


It may be found that the equipment of the factory 
will not enable the production department to keep pace 
with the sales budget, or that the financial department is 
not able to finance it. For these reasons, it may be neces¬ 
sary to revise the sales budget, and bring it into line with 
the other facilities of the business. A finally accepted 
budget should be absolutely free from impossibilities and 
as free as possible from uncertainties. 

Budget and Actual Performance—Reconciliation 

In view of the fact that considerable labor is required 
in the preparation of a budget, and that departmental 
preparation must be made for carrying it out, the results 
forecast and actually realized should be compared at all 
points, month by month, so that responsibility may be 
placed for any failures in the realization. 

Budgetary control bears directly upon all classes of 
expenditures, seeking to reduce injudicious expenses and 
the investment of inefficient capital. It may safely be 
stated, however, that more or less of inefficient capital is 
to be found in all manufacturing businesses, largely result¬ 
ing from internal conditions, discussed in the next chapter 
under the head “Conservation of Invested Capital.” 


CHAPTER IV 


CONSERVATION OF INVESTED CAPITAL 

Waste from Unproductive Capital 

Profitable management, as we have seen, depends upon 
organization for control of operations, and on budgets for 
control of income and outgo of money. It is equally 
important to control or eliminate invested capital employed 
unproductively. Profit is adversely affected by unpro¬ 
ductive capital, just as surely as it is dependent upon pro¬ 
ductively employed capital. 

An insidious accumulation of invested capital not 
capable of productive employment is one of the charac¬ 
teristics of a manufacturing business. Capital of this 
nature usually takes the following forms: 

1. Excessive stocks of raw materials for products not 

currently in brisk demand. 

2. Stocks of raw materials for products which are obso¬ 

lete. 

3. Stocks of scrap material which are capable of being 

utilized or sold. 

4. Inadequate mechanical units. 

Raw Materials and Supplies 

A survey of the manufacturing plants of the country 
would undoubtedly reveal that by far the greater propor¬ 
tion are burdened with excessive quantities of raw 
materials and supplies. The cause is usually the lack of 
pioper records from which an adequate knowledge of 
purchasing requirements may be obtained. 

There are times when abnormal commercial conditions 


34 


CONSERVATION OF INVESTED CAPITAL 


35 


justify purchases in excess of current requirements, but 
at such times the policy should be determined by adequate 
executive authority. Ordinarily, the policy to be pursued 
should be determined from information furnished by 
properly conducted records. It should be clearly under¬ 
stood that an unjustifiably excessive quantity of purchases 
must result in loss from the causes enumerated below: 

1. Loss of interest on capital. 

2. Deterioration. 

3. Physical shrinkage. 

4. Obsolescence. 

5. Storage space occupied, and storeroom supervision. 

6. Waste. 

7. Increased cost of insurance and taxes. 

Losses from the above-stated causes would be mini¬ 
mized by the use of up-to-date stores records, exhibiting 
maximum and minimum requirements for purposes of 
production, and providing a means for keeping the pur¬ 
chasing department in close touch with the various items 
which compose the inventory of materials and supplies. 

Surplus material, prospectively uncurrent, should be 
disposed of, even at less than cost, rather than be allowed 
to remain in the stores department until its only value is 
as scrap. 

Finished Parts and Finished Products 

A fruitful source for reclamation may be found in 
finished parts stores and finished product stores. It is 
surprising to find, after taking inventory, what a large 
amount of working capital has found its way into parts, 
or finished products, that are damaged, obsolete, or in 
excess of future needs. 

The latter condition is usually brought about by the 
common practice of manufacturing—under a special 


36 


PROFITABLE MANAGEMENT 


order—a quantity that is in excess of the order, in the 
expectation that future reorders will be received. When 
the expected reorders fail to materialize, the excess 
product adds to the uncurrent inventory. 

Damaged parts, or parts of an abandoned model, may 
often be salvaged. Unappreciated values in the form of 
product are usually to be found hidden in obscure corners 
of storerooms, or carelessly utilized for purposes which 
could have been served by the use of something less valu¬ 
able. An instance occurred where the end of a factory 
workbench was bolstered up by castings representing a 
considerable value. A piece of wood much less valuable 
than the castings would have better served the purpose. 

Slow-Moving and Obsolete Stocks 

The rapidity with which these accumulations take 
place, when they are not restricted by a properly operated 
cost system, is astonishing. 

One of the prime advantages of a cost system is the 
providing of a perpetual merchandise inventory. If the 
perpetual inventory is fully classified, any stocks of raw 
materials or finished products which are not currently 
usable should be made the subject of particular considera¬ 
tion, with the object of devising the most practicable 
methods of converting their capital value into a form 
which may be of current use. The necessary information 
for accomplishing the purpose should be available from 
month to month, so that unproductive capital investments 
in stock may be exposed as soon as the stocks assume that 
form. Thiough neglecting to use a perpetual inventory 
for the purpose described above, stocks which are not 
current are often not brought to light until a physical 
inventory is taken. Even at that time such stocks often 


CONSERVATION OF INVESTED CAPITAL 


37 


escape detection because they are not classified in a manner 
which will command immediate attention. 

Stocks of Scrap Material 

Enormous stocks of scrap material are often accumu¬ 
lated, little or no attention being given to the possibility 
of profitably disposing of them. This subject is referred 
to again on page I. A correct policy in disposing of 
scrap material cannot be expected if the cost system fails 
to subdivide the scrap properly into its various com¬ 
ponents, so as to account separately for any part which 
may be capable of use in the plant for current product, or 
for by-product purposes, or for sale in the market. 

Inadequate Mechanical Units 

Large amounts of unproductive capital are often found 
to be represented by inadequate mechanical units. The 
fact of inadequacy should be established by cost reports, 
showing failure to attain standards or excessive main¬ 
tenance and repair costs. When such units are retired 
from service they should be disposed of instead of being 
carried indefinitely in an inventory, as is often the case. 
If properly classified, the fact of their existence is not 
likely to be overlooked. 

It may be safely stated that if the requisite vigilance 
is given to the items which enter into an inventory, undue 
accumulations of questionable utility and value will not 
occur, and to that extent unproductive capital will be 
reduced. 

Insurance, Freight Rates, Discounts Receivable 

The opportunities for conserving working capital exist 
no less certainly in connection with insurance freight rates 
and discounts receivable. The fact that there is not so 


38 


PROFITABLE MANAGEMENT 


large a scope for economical effort does not warrant 
neglect of the smaller possibilities. 

Many concerns carry an excessive amount of insurance, 
which entails a loss of the amount represented by the 
premium payments upon the excess. This condition would 
be prevented by the use of insurance records which should 
show the changing values of the various inventories, from 
time to time, and the amount of the covering insurance 
carried. Furthermore, such a record would be the means 
of correcting the liability of carrying either underinsur¬ 
ance or overinsurance upon any part of the inventories. 
Insurance rates may be considerably reduced by the in¬ 
stallation of a sprinkler system. The saving would cover 
the cost of installation in a comparatively short time. 

The payment of freight rates should receive very 
careful attention, to see that the terms under which pur¬ 
chases are made are fully realized, and that the classifica¬ 
tions which form the basis of the rates are correct. 

Where capital is available for the purpose, constant 
care should be exercised for the purpose of fully realizing 
the discounts to be derived from purchases. A deficient 
accounting system, or inefficient clerical services, may 
be responsible for considerable losses in the matter of 
unrealized discounts. 

Budgetary control and conservation of invested capital 
are closely connected with the subject of the next two 
chapters, “Control of Production and of Production Cost.” 


CHAPTER V 


CONTROL OF PRODUCTION AND OE 
PRODUCTION COST 

Relation of Production and Production Cost 

Production and the cost of production are related 
subjects, inasmuch as one is usually affected by the other. 
Low production generally increases the cost, while high 
production usually reduces the cost. Obviously, if the 
volume of production is at full plant capacity, the cost of 
production—all other conditions being equal—will be at 
the lowest point. 

The questions to be determined by a control are not 
limited to the continuous employment of mechanical units, 
although it is important to know which mechanical units 
are not continually employed, and the extent of their idle¬ 
ness. Control is primarily concerned with the quality, 
cost, and volume of output accomplished by the mechanical 
and labor units of the plant. A control of this character 
requires a standard for accomplishment, which may be 
compared with actual performance. This comparison— 
actual performance with standard—is one of the funda¬ 
mentals of efficient control, as brought out in Chapter II. 

Comparison of actual costs with the costs of prior 
periods are very often the only comparisons made. If 
the costs of prior periods do not conform to or improve 
upon standard costs, a comparison with current costs has 
no value greater than showing the extent of any varia¬ 
tions. Even though a comparison is favorable to the 
current costs, the question of how near the current costs 

39 




40 


PROFITABLE MANAGEMENT 


are to standard costs requires determination before the 
state of efficiency can be arrived at. 

Factors in Control of Production 

What, then, are the factors in control of production 
that enable the state of efficiency to be determined? They 
are numerous. Five of the more important are briefly 
considered in this chapter: 

1. The cost accounting system. 

2. Control of scrap and waste. 

3. Relation of the purchasing department to the cost 

of production. 

4. Relation of the sales department to the cost of pro¬ 

duction. 

5. Quality. 

The Cost System—Importance and Functions 

The cost system should be an efficient aid in control¬ 
ling the cost of production. 

The functions of a cost system are briefly expressed 
as follows: 

1. To ascertain actual costs accurately and promptly. 

2. To ascertain the costs of each important and distinct 

step in the manufacturing process. 

3. To provide comparisons which will show the degree 

of efficiency attained in the operations for the 
current period. 

4. To enable the rendering of periodical statements 

promptly. 

5. To enable the preparation of periodical statements 

showing the precise information required by each 
of the various executives, in order that they may 
severally adjust their departments with respect to 
inefficiencies which may be partly or wholly sub¬ 
ject to departmental control. 


PRODUCTION AND PRODUCTION COST 


41 


If a cost system does not give the information required 
by the foregoing purposes, it is valueless. If, though it 
gives the requisite information, the information is not 
properly used, the expense of maintaining the system is 
utterly wasted while such a condition is allowed to con¬ 
tinue. 

The Cost System—Varying Purposes 

It is, of course, quite obvious that the purpose of all 
cost systems is to ascertain costs, but the particular direc¬ 
tion and extent of the purpose, however, should conform 
to the individual requirements of each business for which 
a cost system is employed. 

The fact that costs form the only subject which enters 
into a cost system is often responsible for a lack of special 
adaptation to the individual requirements of a business. 
In many cases the cost system is used for compiling data 
which are not essential to the purposes for which the 
management requires the data. In such cases, although 
the non-essentials are phases of cost, an unnecessary 
expenditure of clerical effort is made in compiling them. 

For example, if the management at three separate 
plants require cost systems for different purposes, it is 
clear that even if the plants and their products were 
identical in all respects the same class of cost data would 
not be required. 

At Plant i. The management is assumed to require 
only such cost data as will enable the preparation of 
financial statements. In this case the purpose of the 
management would be met by a bulking of the costs, 
eliminating as much detail as possible. 

At Plant 2. The management is assumed to require 
the data necessary to guide it in effecting reductions in 
the cost of production. In this case bulked costs would 


42 


PROFITABLE MANAGEMENT 


be of little or no value. Complete details of the costs of 
each operation expended upon the finished product would 
be required. 

The reasons for requiring detailed costs of operations 
are quite clear when consideration is given to the fact that 
when a product undergoes two or more operations the 
total cost is not a conclusive—or even a reliable—indica¬ 
tion of efficient production. The cost of production may 
have been reduced for some operations and increased in 
other operations, the offsetting result in the total cost 
being undisclosed. 

At Plant 3. The management is assumed to be 
interested only in such cost data as will enable the fixing 
of satisfactory selling prices. In this case the required 
cost data would be limited to the total cost of each manu¬ 
factured article or unit of finished product. 

Considering the varying requirements of the foregoing 
hypothetical cases, it would be manifestly unnecessary to 
compile the same class of cost data for each. 

The final purpose of a cost system is to automatically 
provide verifications or controls of the internal accuracy 
of the costs exhibited by the system, and to co-ordinate 
the costs with the general accounts of the business. The 
importance of these purposes justifies the following 
detailed considerations. 

Varying Classifications Required 

The most pronounced feature of all cost accounting 
systems is the extent to which classifications must be used. 
The reason will be clearly understood when consideration 
is given to the fact that classifications furnish the points 
at which costs are to be gathered. The following illus¬ 
tration of manufacturing conditions at factories A and B 


PRODUCTION AND PRODUCTION COST 


43 


shows the necessity for a greater number of classifications 
at factory B: 

Factory A Factory B 

2 products manufactured 5 products manufactured 

3 classes of raw material used 15 classes of raw materials used 

3 operations required 10 operations required 

1 operating department 3 operating departments 

The requisite classifications and their purposes would 
be as follows: 

Factory A Factory B 

2 product classifications 5 product classifications 

The product classifications serve the following pur¬ 
poses : 

1. Costs are gathered for each product. 

2. The cost of each product sold is ascertained. 

3. The selling value is ascertained for each product 

sold. 

4. The gross profit from each product sold is ascertained. 

If product classifications were not used, the total gross 
profit, from all products sold, would be the only informa¬ 
tion ascertainable. The fact that some products may 
have been more profitable than others, or that a product 
may have been sold at a loss, would be undiscovered. 

Factory A Factory B 

3 raw material classifications 15 raw material classifications 

The raw material classifications serve the following 
purposes: 

1. To summarize the quantity and cost of each class of 

raw material which enters into each class of 
product. 

2. To ascertain the cost of each class of raw material 

which enters into each class of product. 

3. To provide for credits being made upon the raw 




44 


PROFITABLE MANAGEMENT 


material stores records for each class of raw 
material used for each class of product. 

Factory A Factory B 

3 operations required io operations required 

Classifications for operations serve the following pur¬ 
poses : 

1. They provide a point which marks each distinct 
stage in the manufacturing process, enabling the costs for 
each such stage to be separately ascertained. This func¬ 
tion is vitally important. It brings to attention the state of 
efficiency which exists in each operation, thereby account¬ 
ing for variations in the costs of each operation, which 
would otherwise be lost to view, that is, the only com¬ 
parison possible would be limited to comparing the total 
cost of the product, one period with another. 

2. Operations provide bases to which many expenses 
may be accurately charged, which would otherwise be 
treated as indirect expenses and distributed arbitrarily. 
This is a most important condition when the output of the 
factory embraces two or more distinct products. 

Factory A Factory B 

i operating department 3 operating departments 

Classifications for operating departments serve the 
following purposes: 

1. Provision is made for encircling the details which 
properly pertain to each department, thereby directing to 
each department the activities assigned to it. 

2. It is possible to place responsibility for the manner 
in which each department is conducted. 

It is, of course, to be understood that, since a multi¬ 
plication of classifications naturally involves a greater 
degree of analysis, classifications will be confined to abso¬ 
lute essentials for placing the important points of a busi¬ 
ness under observation of the management. 


PRODUCTION AND PRODUCTION COST 


45 


Results from a Properly Arranged Cost System 

The comparison on pages 46 and 47 show what was 
accomplished by correctly using a properly arranged cost 
system. The details exhibited by the statements were 
taken from actual results. Therefore it is not a case of 
what a cost system may do; it is a case of what a cost 
system actually did. 

The points of importance in connection with the state¬ 
ments are: 

1. The accounts did not provide reliable cost data 
prior to the installation of the cost system. 

2. The statement for January represents the first cost 
period under the new system. The management was 
astonished upon finding that the average gross profit was 
only 17.2 per cent of the total sales, and the average net 
profit only 8.52 per cent. These disappointing results 
were clearly traceable to departments A, C, and D, partic¬ 
ularly A. Department A was confidently expected to 
contribute the bulk of the profits, inasmuch as it contrib¬ 
uted the bulk of the sales, whereas the operations of the 
department resulted in a considerable loss. 

3. A statement is not shown for February. The change 
of policy shown to be necessary by the January statement 
was not effective before the end of February. The state¬ 
ment for March—the third cost period under the new 
system—shows the effect of the drastic policy put into 
force; shown to be necessary by the statement for January. 

Departments A, C, and D were market lines which, as 
a matter of policy, it was not deemed advisable to dis¬ 
continue. It was, however, decided gradually to reduce 
department A to a practicable minimum, and stimulate 
departments B, E, and G. The result from the change of 
policy is shown by the details given on page 48, which 
appear upon the statement for March. 


Profit and Loss Statement 

For January, 19— 


PROFITABLE MANAGEMENT 




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Profit and Loss Statement 

For March, 19— 


PRODUCTION AND PRODUCTION COST 


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48 


PROFITABLE MANAGEMENT 


The sales of A were greatly reduced, and the relative 
amounts of net profit were considerably increased. 

The net profit for March was.$7,142.56 

The net profit for January was. 3,697.13 

The increase for March being.$ 3 , 445-43 

The vast difference between the state of competition 
which existed a comparatively few years ago and com¬ 
petition of the present day has developed an absolute 
necessity for reducing costs to the lowest possible point. 
This is particularly pressing in the case of manufactured 
products. 

The finished product of every manufacturing business 
represents expenditures for a variety of elements, none 
of which are capable of absolute identification by the most 
expert inspection of a finished product. An expert inspec¬ 
tor of a finished machine, for instance, would be unable 
to determine the exact material cost, labor cost, and over¬ 
head cost which entered into the manufacture of the 
machine. This simple fact should convince manufacturers, 
and their managing executives, that accurate methods must 
be employed for ascertaining the cost of each element in 
the product. 

An Example—Accurate Costs Versus Inaccurate 
^ Costs 

Manufacturers A and B turn out the same line of 
completed product, which is assembled from several parts. 
The business of A is well organized and accurate cost 
information is regularly obtained. The business of B is 
not properly organized. His costs are mere estimates— 
guesswork. The costs of A and B (by chance) show 
practically the same margin of profit for the completely 

assembled product, but there are wide variations in the 
cost of each part. 






PRODUCTION AND PRODUCTION COST 


49 


B Pays the Penalty 

A finds it to be more profitable to purchase a given 
part from B. He therefore ceases to manufacture the 
part in question and obtains his supply from B. 

In the course of time B realizes his disadvantage in 
not having accurate costs. He reorganizes his accounting 
methods and discovers the reasons which induced the pur¬ 
chases by A. The part purchased by A had been supplied 
by B at a price below actual cost. B had been in ignorance 
of the fact because his loss on the part in question was 
covered by his underestimate of profits made on the other 
parts of the completed product. 

It may be noted that B’s actual loss was confined to 
his sales of the particular part to A. A loss did not result 
when he used the part for one of his own assemblies, 
because his costs for the assembled product happened to 
be fairly accurate. 

Another Example—Five Distinct Products Involved 

Now consider the effect of inaccurate cost information 
upon the profits of a business when several lines of 
finished product are manufactured. The supposed costs 
and actual costs were as shown in the table on page 50. 

The difference between the two exhibits show that the 
gross profits from products 1, 2, and 5 were actually 
larger than they were supposed to be, while the gross 
profit from product 4 was actually less. In the case of 
product 3 a distinct loss actually results instead of a sup¬ 
posed profit. 

Value of Cost Information to an Executive 

Obviously, the information—in its present form— 
would not meet the requirements of all of the executives. 


50 


PROFITABLE MANAGEMENT 


SUPPOSED COSTS—PER UNIT 


Product I 
“ 2 


« 

u 

« 


3 

4 

5 


Material 

Labor 

Overhead Total 

Selling 

Price 

Gross 

Profit 

$ 0-95 

$1.20 

$0.25 

$2.40 

$ 3-36 

$0.96 

.40 

.60 

•13 

i -13 

1-58 

•45 

1.20 

•85 

.18 

2.23 

3.12 

.89 

•54 

.70 

•15 

i -39 

i -95 

.56 

2.20 

2.40 

•52 

5-12 

7.17 

2.05 

$ 5- 2 9 

$ 5-75 

$1.23 

$12.27 

$17-18 

$ 4 - 9 i 


ACTUAL COSTS—PER UNIT 


Product i 
“ 2 


a 

a 

a 


3 

4 

5 


[$0.90 

$1.10 

$0.20 

.41 

•58 

. 12 

1-35 

2.02 

• 38 

•56 

•75 

. 16 

2.07 

1.30 

•37 

$ 5-29 

$ 5-75 

$1-23 


$2.20 

$3 36 

$1.16 

1.11 

1-58 

• 47 

3-75 

3.12 

*.63 

1.47 

i -95 

.48 

3-74 

7.17 

3-43 

$12.27 

$17-18 

$ 4 - 9 i 


* A loss. 

Their differing requirements would probably be met by 
varying the exhibits to the following extent: 

For Foremen and Factory Manager. For the 
foreman and the factory manager the details shown by 
the exhibits above would suffice. These executives are 
primarily concerned with the costs of manufacture. Their 
attention would, of course, be immediately directed to the 
causes which brought about the increased material and 
labor costs of product 3. Responsibility for the difference 
between the assumed and actual costs of the product rests 
with them. 

For Sales Manager and General Executive. The 
details shown by the exhibits thus far cover the factory 
costs and gross profits only. The sales manager and the 












































PRODUCTION AND PRODUCTION COST 


5i 


general executive are interested beyond this point, and it 
is therefore necessary to supply them with additional 
details, which will carry the information up to the point 
of net profit from each product. Thus: 


Actual Costs 


Product 

Gross 

Unit 

Profit 

Unit 

Selling 

Cost 

Net 

Unit 

Profits 

Percentage of 
Net Amount 
Profit to Sales 

Units 

Sold 

Percentage of 
Unit Sales 
to Total Sales 

1 

$ 1 .16 

I0.27 

$ 0.89 

26.5 

5.000 

12.5 

2 

• 47 

.13 

■ 34 

21.6 

10,000 

25.0 

3 

*.63 

.05 

*.68 

21.8 

15,000 

375 

4 

.48 

.16 

• 32 

16.4 

8,000 

20.0 

5 

3-43 

• 45 

2.98 

41.6 

2,000 

50 


* A loss. 


The lesson carried by the tabulation to a sales manager 
or a general executive unfolds the following information: 
A loss was made on the particular product which accounted 
for the largest proportion of the total sales. The product 
which yielded the largest net profit showed the smallest 
volume of sales. The correct policy to be pursued should 
be obvious to the minds of the executives. 

Control of Scrap and Waste 

Elimination from industry of those profit-reducing 
factors known as “scrap” and “waste” was considered to 
be of sufficient importance to warrant the attention of a 
committee specially appointed by the Federated American 
Engineering Societies. The committee reported : 

Over 50% of the responsibility for the wastes could be placed 
at the door of management, less than 25% at the door of labor, 
while the amount chargeable to outside contacts is least of all. 

The proportion (25 per cent) laid by the committee at 
the door of labor usually results from causes largely 
eliminable by the supervision of alert foremen. 







5 2 


PROFITABLE MANAGEMENT 


The proportion chargeable to other causes should be 
reduced to the unavoidable minimum. 

The proportion (50 per cent) laid by the committee at 
the door of management, is generally attributable to some 
or all of the following causes: 

1. Extravagant use of materials by machinery and tools 

which are not adequate for the work required. 

2. Failure to specify definitely the size and shape of 

raw material which should be used for cutting or 

stamping operations. 

3. Failure to inspect properly the raw materials put into 

stock from purchases. 

4. Failure to turn scrap to the best advantage by: 

(a) Utilizing it to the fullest extent in the factory. 

(b) Utilizing it as raw material for the manu¬ 

facture of by-products. (In many cases 
subordinate industries have been developed 
for the express purpose of profitably utiliz¬ 
ing regular accumulations of scrap.) 

(c) Caring for it in a manner which will insure 

the best marketing results for scrap sold. 

Methods for Minimizing Losses from Scrap 

The above-stated causes of scrap production clearly 
indicate the methods which should be employed for 
reducing losses from scrap. 

1. A method of control is first in importance. Stand¬ 
ards of efficiency in the use of materials, based upon 
correct machinery and tool operations, would expose any 
unfitness of mechanical units to perform properly the 
work required. 

2. The probability of scrap results should be thor¬ 
oughly considered when materials are put into process. 
Production orders should specify the quantity, grade, size, 
shape, and any other raw material condition which is 


PRODUCTION AND PRODUCTION COST 


53 


known to bear upon scrap reduction. If production orders 
do not specifically cover the above-stated conditions, work¬ 
men may be expected to take the line of least resistance, 
by using sizes or shapes which are the more easily worked, 
without regard to the question of scrap production. Speci¬ 
fications of raw materials to be used provide a basis for 
determining standard scrap production. 

3. The class of work required from machinery, tools, 
and workmen should be the work they are best fitted to do, 
taking into consideration the question of scrap production. 

4. Accounting for scrap production. Although scrap 
material may have little or no value, it must be remem¬ 
bered that its original raw material value is primarily the 
value at stake. All effort to reduce the production of 
scrap are directed to preservation of the original raw 
material value. It is just as necessary to guard against 
avoidable loss from scrap production as it is to guard 
against loss of cash, or any other tangible asset. 

Methods of Scrap Production Accounting 

The method of accounting for scrap production de¬ 
pends upon one or the other of the following conditions 
affecting valuation, which will generally be found to exist: 

1. It may be quite practicable to determine the value 
of scrap which results from the material used for a par¬ 
ticular job, order, or process. In this case no particular 
accounting difficulty arises. The job, order, or process 
receives credit and the scrap account is charged. If the 
scrap is subsequently used in the plant, or sold, it should 
be withdrawn from stores by requisition, in the same 
manner as any other materials. If used in the plant, the 
cost is the value at which it stands upon the stock records. 
If it is sold, any difference between its value upon the 


54 


PROFITABLE MANAGEMENT 


records and the price obtained would require adjustment. 

2. It may not be practicable to determine the actual 
credit which a particular job, order, or process should 
receive for scrap produced. This is the more frequent 
case, and it is often very necessary to employ methods for 
distributing the value of scrap to each job, order, or 
process, upon the most equitable basis attainable. Stand¬ 
ard practice in the use of raw materials furnishes a 
natural basis for equitable distribution of the credits, when 
exact amounts are not practicably attainable. If standards 
are not worked to, the following method of distribution 
will generally give fairly equitable results: 

(a) Standardize the unit quantity of scrap material for 

each job, order, or process. 

(b) Price the scrap at the value for subsequent use. 

(c) Credit the raw material cost of each job, order, 

or process with its proportion (a) priced in 

accordance with (b). 

(d) Charge the scrap account with the credits deter¬ 

mined under (c). 

(e) Credit the scrap account quantities and values with 

scrap requisitioned for use. 

(f) Charge each job, order, or process with the requisi¬ 

tions credited under (e). 

A possible refinement may be required when the 
material cost is high, the quantity of scrap considerable, 
and its value is relatively high. For the purpose of dis¬ 
tribution it may then be necessary to provide tests at more 
frequent intervals in order to verify the standard for unit 
quantity and prevent very appreciable differences between 
the actual amount of scrap and the credits given for it. 

It is also apparent that a standard unit credit may be 
built up from standards applied to the various operations 
required before the product is completed. 


PRODUCTION AND PRODUCTION COST 


55 


The scrap account (an inventory) should, of course, 
be adjusted as occasion may require. 

Purchasing Department—Relation to Production 

Cost 

The purchasing department is in a position to increase 
the profits of the business by closely attending to each of 
the following: 

1. Purchasing from sources which offer the best attain¬ 

able results with respect to: 

(a) Prices 

(b) Quality 

(c) Reliability of service 

2 . Having the right kind and quantity of raw material 

on hand when it is needed, without carrying an 

undue quantity in order to meet the requirement. 

There is much similarity between the methods required 
in conducting a sales policy and a purchasing policy. Apart 
from the difference between the objects in view, very 
similar conditions affect the sources to which sales are to 
be directed on the one hand, and the sources from which 
purchases are to be made on the other. 

A successful purchasing agent should know the con¬ 
ditions of markets from which his purchases are to be 
made. He must have an absolute knowledge of current 
conditions, and a reliable knowledge of prospective con¬ 
ditions. His knowledge must extend to conditions of 
price, quality, and supply. 

Sales Department—Relation to Production Cost 

The sales department is in a position to increase the 
profits of the business by adjusting the sales policy to the 
following: 


56 


PROFITABLE MANAGEMENT 


1. Accomplishing - a volume of sales which will reduce 

the cost of production to the lowest possible point. 

2. Concentration upon the more profitable products. 

3. Close supervision of each member of the selling 

force, the costs of their sales, profits from their 
sales, and results from a territorial point of view. 

In order that the department may be in a position to 
increase profits along the foregoing lines, information 
must be available upon the following points: 

1. The cost department must clearly show the effect 
of varying volumes of production upon production costs. 
This information would enable the sales organization to 
determine readily the extent of losses caused by low pro¬ 
duction. All sales managers know that low production 
means increased cost, but there is a vast difference between 
a knowledge of the fact in a general sense, and an exact 
knowledge of what the loss means in dollars and cents. If 
a sales manager is shown that unused plant capacity is 
causing a loss of profit amounting to $25,000 a year, he is 
more likely to speed up the selling efforts than if he were 
merely informed that the facilities of the plant were 
capable of turning out an additional 20,000 units of 
product. 

2. In order that the department may concentrate its 
efforts upon the more profitable products, information 
must be forthcoming from the cost department as to the 
cost of manufacturing each product, and the net profit 
realized from each product after charging the selling and 
other costs which may fairly be applicable. The essential 
point is that a large manufacturing or gross profit does 
not always indicate a correspondingly large net profit. 

3. The points covered by (1) and (2) above are of 
the precise nature required for enabling a sales manager 
to supervise effectively the individual members of a selling 


PRODUCTION AND PRODUCTION COST 


57 


force, the cost of their sales, profits from their sales, and 
the distribution of their sales territorially. 

Importance of Quality in Manufactured Product 

Quantity of production is universally striven for, 
probably because it is universally understood that quantity, 
cost, and profit are closely allied. It is to be feared, how¬ 
ever, that strife for quantity production constantly tends 
to obscure the equally important matter of quality with 
the result of a general tendency towards deterioration in 
quality. The effect of deteriorated quality is not as 
apparent as quantity variations, nevertheless the effect 
may be infinitely more consequential, because dissatisfied 
customers do not always explain their reasons for dis¬ 
continuing their business relations with a manufacturer 
who turns out an inferior product. As a matter of fact, 
a good quality maintained or improved is one of the most 
potent factors in securing quantity production. On the 
other hand, deterioration of quality is one of the most 
potent influences toward reducing quantity production. 

Quality has become largely a matter of guaranty by 
the manufacturer. Therefore his interests—which natu¬ 
rally involve the interests of his customers—should be 
safeguarded to the fullest possible extent. Whether the 
plant is large or small, whether the product is a piece of 
machinery which may be examined by a purchaser before 
paying for it, or a canned commodity which must be paid 
for before it is possible to use or examine it, the utmost 
care should be used in inspecting the product before it is 
deemed to be of proper quality. 

Inspection for Quality 

Inspection of quality serves three principal purposes: 

i. As a means of guiding the various processes. De- 


PROFITABLE MANAGEMENT 


58 

fects brought to light by inspection are traceable to definite 
causes, which may then be promptly corrected, as, for 
instance, when defective quality is attributable to an im¬ 
proper use of tools or the use of tools which are not 
suitable for the work required. 

2. As a defense against unjust claims for defects. In 
any cases of the kind the claim should be determinable by 
the inspection records. 

3. As a means for maintaining a proper standard of 
quality. In this sense inspection applies to raw materials 
before being put into stock, to patterns before they are 
used, and to any other condition which may adversely 
affect the quality of a finished product outside of the 
manufacturing process. If thorough inspections are made 
along these lines, defects found by inspection of the 
finished product should be practically confined to work 
done in processing. 

The quality of a finished product may not be decisively 
determinable until the product has been used, and then 
the grade may be proved to have been: 

1. Standard quality, that is, uniformly good according 
to established manufacturing practice. This is the degree 
of quality sought by the manufacturer and his customer. 

2. Defective quality developed by usage and reported 
by customers. In these cases special means should be 
devised for enabling the inspection department to de¬ 
termine the existence of similar defects in future product. 

3. Defective but not to an extent which brings forth 
a complaint. While cases of the kind may not result in 
claims by customers, they are particularly destructive of 
good will. Their effect upon a business is therefore to be 
feared more than any other. 

Manufacturers appreciating the importance of quality 
production lay a sure foundation for quantity production. 


CHAPTER VI 


CONTROL OF PRODUCTION AND OF 
PRODUCTION COST (Continued) 

Two Main Factors 

Two of the most important factors in production con¬ 
trol and control of cost are discussed in the present chap¬ 
ter. These factors are: 

1. Planning—insuring correct assignment of work to 

each operating facility. 

2. Standardization—holding the performance of each 

operating facility to a strict accountability. 

The Planning Department as an Aid to Production 

The term “planning department” obviously implies a 
department created for the purpose of arranging the 
manner in which the work of a factory shall be done. The 
necessity for a planning department is a natural outcome 
of standardization, the attainment of a standard being 
largely dependent upon the elimination of hindrance 
caused by inefficient employment of factory facilities. 

A planning department should be responsible for : 

1. Directing the production in a manner which will 

insure continuity of operations—thereby prevent¬ 
ing loss from wasted time, eliminating the ineffi¬ 
cient use of material, and simplifying the opera¬ 
tions by a proper correlation of factory facilities 
with the work they are required to do. 

2. The prevention of undue congestion and delay at any 

point in the manufacturing process. 

3. The employment of each factory facility to the best 

59 




6o 


PROFITABLE MANAGEMENT 


possible advantage, by assigning to each facility 
the class of work which it is best fitted to do. 

4. The prompt detection of causes which interfere with 

the attainment of scheduled results. 

5. Reporting methods for increasing production, which 

may be suggested by the experience of the depart¬ 
ment. 

The planning department is a modern addition to the 
organization of a factory, replacing the ineffective meth¬ 
ods which were formerly employed to accomplish the 
same purpose. Formerly the factory manager and his 
foremen were relied upon to detect and correct all ineffi¬ 
ciencies within the factory. The exactions of present-day 
industry do not permit the continued employment of the 
old-time methods. The planning department introduces 
a highly specialized effort, which relieves the factory man¬ 
ager and foremen of vitally important details which in 
a large factory they could not be expected to supervise 
properly, and leaves them in a position to concentrate 
their entire attention upon quantity and quality of pro¬ 
duction. 

Control of the Flow of Production 

Visualize the difference between the manner in which 
product must pass through factory operations and proc¬ 
esses when it is regulated by a planning department and 
when it is not so regulated. 

When the product is regulated by a planning depart¬ 
ment, it proceeds from point to point with the precision 
of a “personally conducted tour,” scheduled progress 
being made possible by properly made preliminary ar¬ 
rangements and close supervision from commencement 
to completion. When the product is not regulated by a 
planning department, it is apt to proceed through the 


PRODUCTION AND PRODUCTION COST 


61 


plant in an uncertain manner, its precise whereabouts in 
the various operations being largely a matter of conjecture. 

In many large plants the planning department operates 
from two distinct points: 

1. The department assigns work to the various operating 

divisions, but not to the particular operating cen¬ 
ters or machines in the divisions. 

2 . A planning booth under control of the planning de¬ 

partment is maintained in each large operating 
division, the assignment of work to individual 
machines being made by the clerk in charge of 
the booth. 

Results of Planning 

This arrangement places the planning department in 
working contact with each machine, thereby providing a 
flow of work along the line which will insure uninter¬ 
rupted machine operation, as long as the machines are 
in an operating condition. 

The foregoing aspects of a planning department relate 
to smoothing the course of production. An equally im¬ 
portant advantage should be realized from the conserva¬ 
tion of capital employed for producing a given volume 
of product, for the work of a planning department should 
reduce the period of capital employment measured by the 
lapse of time between the purchase of raw materials and 
shipment of the finished product. 

A properly conducted planning department should 
increase the efficiency of any plant. The directions in 
which it should effect its greatest improvements are the 
following: 

i. Directing the course of production, for either specific 
orders or processes, in a manner which directly 
connects each class of product with that part of 
the plant capacity which is best fitted for the work. 


62 


PROFITABLE MANAGEMENT 


2. Scheduling and tracing the production from its com¬ 

mencement to its completion. 

3. Reducing the time during which production is in 

process, the particular advantages being: 

(a) Reduction of the amount of capital locked up 

in a given volume of work in process. 

(b) Increase of the volume of production by the 

same plant capacity. 

(c) Expediting the service to customers. 

4. More economical use of floor space. 

Briefly stated, the department should increase the 
effectiveness of each facility of the plant to the utmost, 
by securing a larger volume of production without increas¬ 
ing the investment for buildings and mechanical units. 

Standardization of Products and Costs 

There are two forms of standardization which play 
an important part in present-day manufacturing busi¬ 
nesses : 

1. Standardizing the product. 

2. Standardizing the costs. 

Competitive conditions have made standards necessary, 
and further development in competition may confidently 
be expected to make standardization more imperative. 

Standardizing the Product 

When product is manufactured for an open market, 
the conditions of its manufacture are apt to remain un¬ 
changed except as to such improvements as may result 
from continuous experience in the manufacturing process. 
Standardizing the product virtually provides a specifica¬ 
tion of each requirement which enters into it. In this way 
it is possible—and very necessary—to govern the manu¬ 
facture with a precision which is not otherwise attainable, 


PRODUCTION AND PRODUCTION COST 63 


particularly with respect to a steady flow of product from 
one operation or department to another, and to preserve 
an even state in the matter of quality. 

In addition, the standardizing of product largely 
reduces clerical details by eliminating the necessity for 
using many separate factory forms. 

Standardizing the Costs 

The standardization of costs is not, of course, confined 
to standard product. Standard costs should represent 
the lowest costs fairly attainable, after considering the 
individual facilities of the plant which are to be employed 
in the manufacturing process. A standard is possible, 
and desirable, for any class of product; a staple product, 
however, offers fewer causes of variation between actual 
and standard costs. 

Standards of cost are now widely recognized as the 
only costs with which actual costs should be compared. 
Often, as noted in Chapter V, the only comparisons made 
are of actual costs with those of prior periods, notwith¬ 
standing that the value of such comparisons is limited to 
the variations which may be shown. If the costs for a 
given period show a reduction, as compared with the costs 
for a prior period, the result is satisfactory to that extent, 
but the more important question for determination is: 
How do actual costs compare with standard? Until the 
standard is equaled or excelled there cannot be complete 
satisfaction with current performance. 

Standards for individual accomplishment should be 
based upon effort which may reasonably be sustained, so 
that failure to attain the standard may be made the sub¬ 
ject of investigation in connection with the work of 
individuals or groups. 


PROFITABLE MANAGEMENT 


64 

Standards as a Means for Reducing Costs 

The preparation of standard costs for a standardized 
line of product is probably to be accomplished with 
greater facility and certainty than is possible when stand¬ 
ard costs are prepared for product manufactured under 
varying specifications. The operations and processes 
which standard product undergoes are largely repetitions, 
capable of being accurately standardized with respect to 
each element of production cost—material cost, labor cost, 
and overhead cost. 

Variations between standard and actual costs would 
ordinarily be traceable to one or more of the following 
causes: 

1. Variations in cost of materials: 

(a) Variations in the cost price of materials. 

(b) Variations in the cost of materials, caused 

by an excessive use of materials, that is, 
an inefficient use of materials. 

2. Variations in cost of labor: 

(a) Variations in the rate of wages paid. 

(b) Variations caused by a lower production, that 

is, an inefficient use of labor. 

3. Variations in cost of overhead. 

There are two classes of overhead charges: 

1. Fixed overhead. This class includes charges for 
rent, supervision, interest, insurance, depreciation, etc., 
which are practically unaffected by volume of production. 

2. Variable overheads. This class includes charges 
for indirect labor, general operating expenses, etc., which 
are more or less uncertain as to amount and as to the 
time at which they will be incurred. 

A comparison of standard overhead cost with actual 
overhead cost should trace any difference to the particular 
class of overhead which has varied from the standard. 


PRODUCTION AND PRODUCTION COST 65 


Comparison of Standard and Actual Costs Illustrated 

The effective comparisons possible between standard 
and actual costs are shown by the following example: 

Standard Costs for ioo Units of Standard Product 


Cost of materials to be used.$200.00 

Cost of material in scrap, or waste. 2.00 

Cost of labor, 200 hours at 50c. 100.00 

Cost of overhead: 

Fixed .$20.00 

Variable . 10.00 30.00 


Total .$332.00 


Actual Costs of ioo Units of Standard Product 

Cost of materials used.$200.00 

Cost of materials scrapped, or wasted. 3.00 

Cost of labor, 205 hours at 52c. 106.60 

Cost of overhead: 

Fixed .$20.50 

Variable .. 11.90 32.40 


Total 


$342.00 


The actual costs exceed the standard costs by $10, to 
be accounted for as follows: 

Inefficient use of materials.$ 1.00 

Cost of labor, 200 hours at 2c.$4.00 

Inefficiency of labor, 5 hours at 52c. 2.60 

Fixed overhead—rate of 10c per hour—inefficient produc¬ 
tion, 5 hours at 10c. .50 

Variable overhead—rate of 5c per hour—inefficient pro¬ 
duction, 5 hours at 5c. .25 

Increase in expenditures. 1.65 


$ 4-35 
$5-b5 5.65 

$10.00 

No great difficulty would be encountered in discover¬ 
ing the reasons for inefficient use of materials or for 
inefficient production. An investigation of the increased 
overhead cost, however, would require a comparison of 
each class of expenditure which entered into the standard 

































66 


PROFITABLE MANAGEMENT 


cost, with the similar classes of expenditures which entered 
into the actual costs. The comparison would bring to 
light any improprieties in the matter of expenditures. 

The essential requirements for standard cost are 
accuracy and absolute practicability. Contrast the fore¬ 
going example with the usual procedure followed in cases 
where costs are not standardized: The total of the actual 
cost, shown by the example to be $342, or $3.42 per unit, 
would be compared with the total cost for a previous 
period. If the comparison showed the same result, the 
manufacturing part of the business would be considered 
to be fairly satisfactory. If the current period showed a 
reduction in the unit cost, great satisfaction would prob¬ 
ably be expressed, notwithstanding the probable fact that 
the performance for the current period is not up to the 
requirement of a standard. 

Although, as previously stated, the preparation of 
standard costs is easier of accomplishment for standard 
products than for products which are not stock lines, it is 
nevertheless possible and very desirable to apply standard 
costs to such products regardless of the varying specifica¬ 
tions under which they are manufactured. 

As a matter of fact, the necessity for standards is 
equally—perhaps more—important, because the constant 
repetition of standard manufactures certainly furnishes a 
means for measuring the volume of production which 
should be accomplished, whereas special products are apt 
to dififer in every particular. As a rule, businesses which 
turn out special products have the least reliable cost data 
for use in controlling the costs. For such businesses, 
therefore, control by standards is of exceptional benefit. 
In these cases, standards would be formed from specifica¬ 
tions which govern the manufacture of the product, and 
any abnormal differences between standard and actual cost 


PRODUCTION AND PRODUCTION COST 67 


would show a necessity for reviewing the standard, with 
the object of confirming it. 

If statistical cost data are available from past experi¬ 
ence the preparation of standards for special product will 
be greatly facilitated. 

Object of Standards 

It must be borne in mind that the object of setting 
standards for any class of work is to obtain the best pos¬ 
sible results for both employee and employer. It is there¬ 
fore necessary to establish labor standards which are 
thoroughly practicable, particularly with respect to what 
should be accomplished by sustained effort. 

The working force actually engaged in the manu¬ 
facturing operations is, of course, the most important 
factor of the business to be controlled by standards, but 
there is no reason why standards should not be applied 
to certain classes of indirect labor. Much of the clerical 
work in an office, for instance, is susceptible to standard 
control. Posting the records, computing the costs, pre¬ 
paring sundry tabulations, etc., may be governed by 
standards which would enable a regular schedule to be 
maintained by a well-balanced clerical force. 

Standardization of Clerical Work 

Notwithstanding that the importance of working to 
standards is very generally appreciated so far as factory 
product is concerned, the possibility of applying standards 
to the clerical work of a large office and factory is often 
overlooked. Much of the work to be done in handling 
and tabulating the various factory records is susceptible 
to standardization by fully utilizing the mechanical devices 
usually found in large offices and factories. 

Although very effective machines and appliances have 


68 


PROFITABLE MANAGEMENT 


been devised for correctly and quickly handling matters 
of an accounting nature, a very small proportion of manu¬ 
facturers have availed themselves of these excellent aids. 
Just as in manufacturing, the machine for office use has 
replaced manual work, giving more satisfactory results. 

The use of pen and ink for financial and statistical 
accounting is certainly giving way to the mechanical 
appliance. 

In cases where a great number of cards are to be 
sorted and tabulated to a very fine distribution, handwork 
is inefficient and expensive. The modern punch card 
systems which record, analyze, and distribute are not used 
to the full extent of their capabilities. Plants have been 
investigated where such equipment was in use, but where, 
in many instances, essential facts and figures which would 
have been of value to an executive were not obtained. 
Generally, this lack of completeness was attributable to a 
lack of knowledge both as to the statistical requirements 
and the capabilities of the equipment for producing the 
requisite information. 

The Question of Labor Conditions 

Control of production and of production cost is vitally 
affected by labor conditions. Unsettled labor conditions 
are liable to destroy plans based upon forecasts necessary 
for a proper degree of control. The subjects dealt with 
in the next chapter are of a remedial nature, bearing upon 
compensation of workmen and the shop conditions under 
which their work is carried on. 


CHAPTER VII 


LABOR 

Labor Effectiveness and Production 

In Chapter I it was stated that alert, resourceful execu¬ 
tives will recognize improvements in production as being 
one of the important lines leading to profitable business. 
Improvements made possible through improved machinery 
and tools usually force their way into general use by 
reason of their pronounced effect as factors of compe¬ 
tition. Such improvements must be installed if a manu¬ 
facturer is to maintain his position in the industry. 

Improvements in production, however, are not limited 
to improved mechanical appliances. The labor, manual 
and other, of the individual workman is a factor of vast 
importance, and it is possible of full development only by 
employing methods calculated to encourage his best efforts. 
The best efforts of a working force numbering hundreds, 
or thousands, represent improvements in production which 
a progressive employer cannot afford to disregard. 

The subject is outlined in the present chapter with 
special reference to wage systems and to methods of 
encouraging workmen to suggest improvements in methods 
of reducing the causes of labor turnover, and of training 
foremen in the cost of handling men. 

The prime requirement of present-day industry is 
centered in volume of production. The contributory 
reasons are well worth considering; in fact, in most cases 
they are forced upon the attention of business men in 
some form or other, although not always with such direct¬ 
ness as may be necessary for unmistakably connecting 

69 


70 


PROFITABLE MANAGEMENT 


effect with cause. The importance of the subject requires 
the employment of the most effective accounting methods 
for ascertaining and exhibiting all of the conditions which 
are affected by a low or high rate of production. Such 
conditions will principally be found to be: 

1. The larger quantities of materials required for a 

larger volume of production may be purchased to 
better advantage. 

2. A larger volume of production means a fuller em¬ 

ployment of plant capacity and a corresponding 
reduction of cost per unit of product, for fixed 
charges, and in the general overhead rate. 

3. Reduction in the direct labor cost, per unit of product, 

resulting from the stimulating effect of wage pay¬ 
ment plans which are expected to induce greater 
individual effort. 

The Stimulus of Wise Wage Payment Plans 

The effect of conditions 1 and 2 is more generally 
understood than is the effect of condition 3. It is generally 
conceded, however, that a daily or weekly wage rate is 
suitable only in cases where the labor performed has no 
measurable relation to product. It will readily be seen 
that when labor is directly applied to the product, a fixed 
rate of wage, if not modified by conditions which com¬ 
pensate special effort, is open to two very serious objec¬ 
tions : 

1. It does not invite special individual effort. 

2. Uniform labor costs cannot be ascertained because, 

although the wage rate is uniform, productivity 
varies. 

The question of increasing the compensation of labor 
proportionately to increased production has found prac¬ 
tical expression in the numerous methods of bonus pay- 


LABOR 


71 


ments now being employed, all of which are variations of 
piece rates. 

Piece Rates—Most General Form of Bonus 

The philosophy which underlies all systems for pay¬ 
ing wages in proportion to the amount of good work done 
is based upon the thought that special incentive is a stimu¬ 
lant for greater individual effort. Setting piece rates, or 
setting rates for any of the variations which are based upon 
units of work done, requires the utmost care, for if any 
of the undermentioned conditions vitally necessary for the 
successful operation of rates based upon effort are not 
recognized in the rates, the result will assuredly be dis¬ 
appointing if not actually disastrous. 

In the first place, rates must be based upon reasonable 
wages for reasonable effort. The paramount question for 
decision in arriving at a sound basis is: How is effort to 
be determined as being reasonable? A correct answer is 
possible only after carefully considering each factor which 
enters into each particular class of work for which rates 
are required. 

For instance, if the work of an employee is exclusively 
handwork, the foremost questions to be determined are: 

1. The nature of the work to be done, with particular 
reference to the mental and physical efforts required for 
steadily carrying it on. Mental and physical fatigue are 
involved in all classes of work, to a greater or lesser 
extent. They are factors to be carefully considered in 
setting piece rates, because the rates should properly com¬ 
pensate an effort which is capable of being sustained. 

2. The nature of the materials should be carefully con¬ 
sidered. Some materials are handled with greater ease 
than others, and with a greater degree of certainty in turn¬ 
ing out the product. Allowances must be made for any 


72 


PROFITABLE MANAGEMENT 


characteristics which tend to impede the course of produc¬ 
tion, particularly such as the workman is not able to con¬ 
trol. 

In the second place, if machines or special tools are 
used by the workman, it would probably be necessary to 
take into consideration the extent to which his volume of 
production is affected by: 

1. Preparing the machines or special tools for the 

work to be done. 

2. Removing the particular arrangement of machines or 

special tools after the required work has been 
completed. 

Modern methods determine piece rates from a careful 
study of the constantly repeated motions employed by the 
workman in each operation and the timing of the motions. 
The importance of thoroughly considering each factor 
which may be responsible for variations is obvious. The 
rates—necessarily based upon observations confined to a 
small number of representative workers—may be applied 
to thousands of workers. 

If the rates do not rest upon a proper basis, they will 
be too high or too low. If too high, the object in setting 
the rates will be defeated. Workmen will inevitably 
slacken their efforts, fearing a reduction of the rate. If 
too low, the workman will be dissatisfied and request a 
revision. Piece rates will not endure a test if they are 
not absolutely equitable to employer and worker. 

It cannot be seriously contended that some form of a 
bonus stimulant for foremen would be as productive of 
intensified effort as in the case of individual workmen. 
Logically considered, encouragement of intensified effort 
by a foreman should bring about a greater degree of 
efficiency by each mechanical and labor unit which he 
supervised, hence the importance of including him as 


LABOR 


73 

one of the factors necessary to the realization of increased 
profits. 

Suggestion Systems and Efficient Production 

The object of a suggestion system is clearly shown by 
the following invitation addressed to the workers employed 
by the Yawman and Erbe Manufacturing Company, in 
the company’s plant publication issued at regular intervals: 

Turn your ideas into cash. Improvements on machinery, re¬ 
duction of costs, betterment of factory and office conditions—these 
are the subjects on which your suggestions are needed. How 
many times have you thought that such and such an idea would 
help with your work? Write it down and send it to the suggestion 
board, where it will be considered and given a trial, and if prac¬ 
tical it will not only bring you a cash prize, but will stand as a 
good mark for you in the eyes of your department head, inci¬ 
dentally helping you towards promotion at a future date. 

At regular intervals, the action of the board of awards 
is published. A list of the prize winners is given, together 
with a brief description of the suggestion and the board’s 
comments thereon. 

The system is based upon the sound assumption that 
if properly encouraged, intelligent workmen may be relied 
upon to study ways and means for improving their 
methods and the character of the product. 

Labor Turnover—Its Effect on Production 

Up to a comparatively recent period the important 
effect of labor turnover upon the production of a factory 
escaped official recognition. Undoubtedly, an improperly 
compensated earning capacity is the chief cause of work¬ 
men transferring their services from one place of employ¬ 
ment to another, but there are other causes which demand 
the most careful attention of the management. Present- 


74 


PROFITABLE MANAGEMENT 


day business methods have reached a point at which labor 
turnover is a factor which must be dealt with. 

The expression “labor turnover” is used for denoting 
the percentage rates at which workmen enter and leave 
the service of a business. Such changes in personnel tend 
to increase the costs of a business for the following 
reasons: 

1. Increased cost results from decreased production 
per labor unit employed. This will usually follow, be¬ 
cause, even though it may be possible to readily replace 
workmen who leave the service, it is rarely the case that 
an incoming workman will immediately show a production 
capacity equal to the capacity of the outgoing workman. 
The difference in productive capacity would probably be 
very marked if a special degree of skill were required. 

2. Increased cost results from decreased production 
per labor unit employed, and from other conditions conse¬ 
quent upon a more or less extended period of training. 

Investigation of Causes 

The effect upon costs is unquestionable; therefore, 
investigation as to the causes of labor turnover is very 
essential in order that the cause and effect may be gov¬ 
erned as completely as possible. 

To put the subject in a concrete form, assume the 
following to be facts: During a given period, ioo work¬ 
men have left the service; 25 were discharged for cause, 
75 voluntarily withdrew. 

An investigation would probably determine the neces¬ 
sity for action somewhat upon the following lines: 

1. With respect to the discharges. The causes would 
determine the advisability of adopting more care¬ 
ful methods in' investigating applicants for em¬ 
ployment. 


LABOR 


75 


2. With respect to the voluntary withdrawals. An in¬ 
vestigation would probably establish one, or several, 
of the following causes: 

(a) Objectionable shop conditions: Lighting, 

heating, ventilation, etc. 

(b) Inconsiderate treatment by those in authority. 

(c) Lack of opportunity for advancement. There 

may be no encouragement for suggestions 
which may lead to improvements in manual 
and mechanical methods. Or the plan upon 
which wages are paid may not properly 
induce and compensate special effort. 

Modern factory practice fully recognizes the impor¬ 
tance of applying the most careful consideration to 
methods for eliminating the above-stated causes of labor 
turnover. 

Training—Aid to Greater Efficiency 

A systematic course of technical training is practiced 
by many larger manufacturing concerns with the object 
of increasing the efficiency of individual workers by im¬ 
proving the methods for carrying out individual labors 
and educating the workman with respect to the inter¬ 
relation which exists between his own work and the work 
of the plant as a whole. 

Training is largely carried out in evening classes, held 
within the plant, instructed by competent employees under 
official supervision. 

To be thoroughly effective, all systems for individual 
training must be based upon a correct knowledge of the 
workmen’s deficiencies, so that the men may be properly 
grouped for class instruction. Grouping will usually fol¬ 
low the following lines: 

1. Foremen who require training. 

2. Workmen—fast workers—who turn out a large 


76 


PROFITABLE MANAGEMENT 


volume of inferior quality. This sort of man 
requires instruction which will improve the quality 
of his work. 

3. Workmen—slow workers—who turn out a small 
volume of good quality. This sort of man requires 
instruction which will increase the speed of his 
work. 

Foremen as Instructors of Workmen 

Foremen are naturally expected to understand fully 
how the work should be done, but unless they also under¬ 
stand the art of teaching the workmen, they will fall short 
of accomplishing the desired results. 

A constant use of labor standards will not instruct 
the workmen when they lack the knowledge for doing the 
work in standard time. Nor will driving tactics accom¬ 
plish the desired result. Workmen may confidently be 
expected to show an appreciative spirit when the manage¬ 
ment shows a disposition to instruct them in methods for 
overcoming their difficulties, and without question they 
will exhibit a greater respect for the foreman who teaches 
them. 

Assuming a foreman to be quite competent to teach 
his men, he must have some reliable means for indicating 
which men require instruction and the class of instruction 
required. If the foreman supervises a number of men, 
he will require the assistance of a charted record showing 
the quantity and quality production of each workman. 
The charts will enable him to locate the deficiencies in 
each case, and provide the class of instruction necessary 
for overcoming them. It is not necessary to base the 
charts upon specific performance, arrived at from motion 
studies. The pressing necessity is to instruct the worker 
to do his work in the best known manner at the time he 
is being instructed. Therefore the charts may be based 


LABOR 


77 


upon a fair amount of productive work measured by 
known conditions. After the productive ability of all 
workers has been properly developed to meet known con¬ 
ditions, a scientific standard may be aimed at. 

Training Foremen for Better Work 

There should not be any doubt in the minds of gen¬ 
eral executives that good foremanship is one of the most 
important factors in determining the success of any busi¬ 
ness in which foremen are employed. It is not possible 
to establish an industry upon a profitable basis unless the 
three admitted factors of efficient production are taken 
into account: efficient co-operation between the members 
of gangs and departments; low costs; quality production. 
These are within the province of good foremanship; 
therefore, they suggest the particular direction to be 
taken in training foremen. 

Efficient Co-operation 

The foremost qualification of practically all foremen 
is the ability effectively to supervise technical processes. 
Foremen may usually be depended upon to possess the 
qualifications, by reason of the fact that their promotion 
from the ranks of workers is a recognition of unusual 
ability and skill. It is with reference to their duty of 
supervision that foremen require training if they are to be 
equipped for successfully handling collateral conditions, 
equally important with skill, in the technical processes. 
If a foreman, though skilled to the utmost degree in 
technical work, is deficient in other requirements of good 
foremanship, his deficiencies will most certainly be respon¬ 
sible for failure to accomplish the following absolutely 
indispensable results: 

i. Reduction to a minimum of friction within his 


78 


PROFITABLE MANAGEMENT 


department. This is to be accomplished only by studying 
the individual characteristics of his men; determining 
their strong points and weak points; encouraging the one 
and eliminating or strengthening the other. It is rarely 
the case that a foreman promoted from the ranks pos¬ 
sesses a natural ability to handle men properly. To the 
contrary, his rise to an official position more often leads 
to the employment of “driving tactics,” now widely recog¬ 
nized as destructive of good management. For the aver¬ 
age foreman, training should be commenced with instruc¬ 
tion in the correct methods to be followed in handling his 
men. 

2. If a foreman is not properly instructed in the 
relations which exist between his department and other 
departments, the various departments cannot be expected 
to operate with the precision required of the factory as 
a unit. Time will inevitably be wasted because of one 
department failing to promptly deliver its product to 
another. 

3. If a foreman is not properly instructed as to the 
manufacturing policies of the general management, he 
cannot be expected to contribute his share towards giving 
effect to those policies. 

4. Improving the processes, reducing waste, and tak¬ 
ing advantage of all possible means for securing a greater 
degree of efficiency in production. These economies are 
all possible to good foremanship; in fact, the foreman is 
the logical means for their accomplishment. 

Good Foremanship and Low Costs 

The small economies made possible by personal con¬ 
tact of alert foremen with the daily work of the factory 
may aggregate an importance equal to the economies which 
result from the higher management. A foreman’s sug- 


LABOR 


79 


gestions for improving factory methods will naturally 
apply to conditions observable only by one who is in con¬ 
stant contact with the work. No effort should be spared, 
therefore, in encouraging him in such work. If he is 
thoroughly instructed in the production policy of the 
management, he will exert his best efforts to sustain the 
policy, as far as his department is concerned. His 
ambition should be keyed up to the point at which he is 
constantly on the lookout for opportunity to: 

1. Stop small losses. If small losses are detected and 

stopped, a decided gain will have been made in 
factory discipline in addition to the actual saving 
of cost. 

2. Reduce loss through defective work. 

3. Reduce loss occasioned by idle time. 

4. Make a more effective use of working space. In¬ 

stances have occurred in which a capable foreman 
has effected economies in the use of floor space, 
large enough to obviate the supposed necessity 
for providing an additional building. 

Good Foremanship and Maintenance of Quality 

Quality is perhaps the most important factor in com¬ 
petition. The business man who has won general con¬ 
fidence in the quality of his goods has established a valu¬ 
able good will. 

The preservation of that good will rests almost entirely 
upon the foremen. If they are taught the vast importance 
of maintaining their employer’s standard of quality, or 
even improving it within specified limits, their personal 
pride will be enlisted in the work. Raw materials from 
the stores will be carefully scrutinized, notwithstanding 
the inspection when purchased. Operations and processes 
will be carefully watched, and workmen instructed upon 
the subject of quality maintenance. 


8o 


PROFITABLE MANAGEMENT 


Shortly stated, trained and untrained foremen will 
differ in the following respects: Trained foremen may be 
relied upon to preserve harmonious working relations, 
carry out management policies, and eliminate all adverse 
factors. Untrained foremen endanger management poli¬ 
cies ; they often create friction in the ranks of the workers; 
they fail to lower the costs and maintain quality of pro¬ 
duction. 


CHAPTER VIII 


UNIFORM COST-FINDING METHODS 

Standardization of Cost-Finding Methods 

The present chapter deals with a form of standardiza¬ 
tion which differs in character and import from the 
standardization discussed in Chapter VI. The latter 
bears directly upon the products of a factory; its effect 
is therefore internal. The subject of the present chapter 
bears equally upon all factories comprehended within a 
trade association, the effect being external. 

The discussion which follows shows the importance 
of standardized cost-finding methods for ascertaining the 
cost of competitive products of the same class. 

The expressions “uniformity of cost-finding methods” 
and “uniformity of cost systems” are often erroneously 
used as denoting the same thing. The former relates to 
uniformity in construing cost-finding principles for the 
purpose of ascertaining costs. This is both possible and 
desirable in respect of any manufacturing business, par¬ 
ticularly so with respect to similar businesses. The latter 
embraces the former, but it also relates to uniformity 
of accounting procedure for the ascertainment of costs. 
It is both possible and desirable, however, to establish 
uniform methods for expressing cost accounting princi¬ 
ples which are common to all manufacturing industries, 
particularly with respect to the following: 

i. As to variations in cost accounting terminology, 
which variously express the same thing. Thus: “indirect 
expenses,” “overhead,” “burden,” are each expressive of 
the same thing, the expression “indirect expenses” being 

81 


82 


PROFITABLE MANAGEMENT 


preferable. “Non-productive labor” and “indirect labor” 
are commonly used to indicate the same thing, and they 
very often do, but each expression has its own particular 
significance. All labor is productive of something; there¬ 
fore the expression “non-productive labor” (meaning 
labor not directly employed upon a product, which cannot 
be definitely assigned to the product) is not as expressive 
as “indirect labor.” 

2. As to variations of classifications: All cost account¬ 
ing systems represent an analytical division of the ex¬ 
penditures incurred in the processes of manufacturing, 
the object being to state the costs for each important 
separable stage of manufacture. For this purpose, classi¬ 
fications are required, some of which are common to all 
industries. In the case of similar industries similar classi¬ 
fications are largely applicable, notwithstanding the vary¬ 
ing conditions under which such industries are conducted. 
The varying conditions referred to undoubtedly require 
variations in subclassifications, but the primary classifica¬ 
tions are generally unaffected. All manufacturing indus¬ 
tries consume more or less of raw materials, employ 
direct labor, and incur indirect expense, all of which is 
to be accounted for according to principles which are 
unalterable. The accounting is done under a system 
which may vary to any required extent, but the unalter¬ 
able principles—if correctly represented by the system— 
are subject to the same form of treatment. This uniform 
treatment (uniformity of method) is the advantage 
sought by “uniform methods of cost accounting,” and it 
will be accomplished, to a great extent, by the employ¬ 
ment of uniform classifications. For instance, if two 
manufacturers engaged in the same industry classify 
direct material and direct labor differently, the differing 
classifications will probably reflect similar differences in 


UNIFORM COST-FINDING METHODS 


83 


the indirect expenses of the two plants; a comparison 
of the detailed costs will therefore be impossible without 
first reducing the costs of each to similar classifications. 
In other words, the costs would require an analysis which 
would not be necessary if uniform methods were observed 
in the use of classifications. The advantages of uniform 
methods have been recognized in commercial businesses 
which are not of a manufacturing character. The Federal 
Reserve Bank, for instance, devised a uniform form of 
balance sheet to be used by member banks. 

Primary classifications are uniformly possible in all 
businesses to which the subject of the classification is a 
factor. The subject of uniform classifications is, there¬ 
fore, to be considered from the following viewpoints: 

1. Uniform classification of all accounts. 

2. Uniform methods for including under all primary 
classifications the same constituent details. Thus, there 
should not be any variations as to what class of expendi¬ 
tures constitute “manufacturing costs,” “selling costs,” 
or “administrative costs.” Uniformity in these respects 

^WQUld secure uniformity in the language of costs, which 
for comparative purposes is greatly desirable. 

The activity now being devoted in various industries 
to the securing of uniform cost accounting methods is 
mainly prompted by manufacturers who know their costs, 
seeking to defend their business from pernicious competi¬ 
tion by manufacturers who do not know their costs. 

A manufacturer who knows his costs and who con¬ 
ducts his business in an economical and efficient manner, 
establishing fair selling prices from the basis of his costs, 
will not fear competition from another manufacturer who 
conducts his business upon similar lines. Competition 
is to be feared from the manufacturer who does not 
know his costs. He may be selling product at a loss 


8 4 


PROFITABLE MANAGEMENT 


without knowing it. In the majority of cases, his faulty 
costs (usually understated) are responsible for absurdly 
low selling prices, which ultimately result in his failure. 
In the meantime, however, he has visited his misfortunes 
upon the particular industry in which he was a competitor. 

His costs may be erroneous in any of the following 
directions: 

1. He may correctly figure the cost of the amount of 
material which should go into the product, but may not 
correctly figure loss from waste and defective work. 

2. He may correctly figure the direct labor cost, from 
standard performance as the basis, but may not take 
into account the loss occasioned by “waiting time” result¬ 
ing from neglect of workmen, foremen, or unbalanced 
operating departments. 

3. Usually, the greater part of his errors will be 
found in his methods for arriving at the indirect expenses 
and distributing them to the product. He often currently 
uses the percentages applied for previous years, without 
regard to the actually incurred indirect costs of the cur¬ 
rent period, or variations between the two periods as 
regards the volume of product to which the indirect costs 
are to be distributed. 

4. He may erroneously classify as indirect costs items 
which are in reality direct costs. This error, of course, 
may result in a distribution to several products of a factor 
of cost which should be borne by a single product. In 
such a case the manufacturing profit from the single 
product would be overstated, thereby influencing the sell¬ 
ing price, in the direction of its reduction. 

5. In the most important matter of providing for 
depreciation of his plant and equipment, he very often 
regulates the provision—if he makes any—in conformity 
with the profits he supposes to have been made, without 


UNIFORM COST-FINDING METHODS 85 

regard to the principles which should determine the cost 
of depreciation. 

As a matter of self-preservation, manufacturers who 
conduct their business in an efficient manner must spare 
no effort to induce the inefficient competitor to adopt 
cost-finding methods which will exhibit true results, not 
for his own benefit only but also for the benefit of the 
industry at large. This is what many manufacturers are 
now doing. 

In order to accomplish the best results from uni¬ 
formity of methods a survey should be made of the par¬ 
ticular industry, comprehending a sufficient number of 
individual plants—large, intermediate, and small—for the 
purpose of determining the points of variation in methods 
which should be made uniform in all plants irrespective of 
their magnitude. In other respects, uniform methods 
should be devised with due regard to factors which con¬ 
stitute manufacturing differences, each business in the 
industry which is governed by similar factors being sub¬ 
jected to identical methods as far as may be possible. 

The following considerations must receive attention: 

1. The classification of accounts. 

2. The methods of receiving, storing, and delivering 

raw materials. 

3. The method of recording time. 

4. The method for reporting production. 

5. The method for compiling the cost records. 

6. The method of accounting for factory indirect ex¬ 

penses. 

7. The function of the general ledger. 

8. The methods to be followed for submitting periodical 

reports to executives, and between members of an 

association, for comparative purposes. 


86 


PROFITABLE MANAGEMENT 


Benefits of Standardization 

The initiative for bringing about this form of stand¬ 
ardization rests upon associations of manufacturers, and 
the object to be standardized is the employment of uni¬ 
form cost-finding methods by each member of the asso¬ 
ciation. 

Uniformity of method is prescribed for each industry 
after an examination has been made of the manufacturing 
conditions at each plant operated by members of the 
association, the prime object being to have each member 
arrive at his costs in the same manner for such costs as 
are common to all. By this means it is expected to elimi¬ 
nate the cutting of prices by manufacturers who have not 
previously had a correct knowledge of their costs. 

It should be understood that uniform cost-finding 
methods do not attempt to regulate either cost account¬ 
ing systems or selling prices. Uniformity is centered 
upon and limited to the costs of manufacture; it is there¬ 
fore largely concerned with similar classifications for 
similar classes of expenditures. 


CHAPTER IX 


MARKETING THE PRODUCT 

Sales Policy 

The objective of all sales policies is to increase the 
profits of a business through the increased production 
which naturally follows increased sales. This object is 
not always to be accomplished through an intensification 
of selling methods. Determination of a correct sales 
policy often involves consideration of the relationship 
which exists between a correct selling price and the gross 
profit from varying volumes of production. 

By way of example, assume the following to be facts: 

1. The production of a factory is 100,000 units. 

2. The factory is capable of turning out 150,000 units. 

3. The factory costs are: 

For an output of 100,000 units, $200,000. 

For an output of 150,000 units, $270,000. 

4. The selling value of 100,000 units of production is 

$240,000. 

5. An increase in the volume of sales is not possible at 

current prices. 

Assume, further, that the sales organization has been 
informed by the cost department that an expansion of 
the sales from 100,000 to 150,000 units would reduce the 
cost of production by 10 per cent. 

Acting upon the information, the sales department 
finds it possible to stimulate sales to the required volume 
of 150,000 units by reducing the selling price from $2.40 
to $2.10 per unit. Upon this basis, the comparison of 
results would be: 


87 


88 


PROFITABLE MANAGEMENT 


Gross profit from 100,000 units..$40,000 

Additional gross profit from the increased production of 

50,000 additional units sold. $5>°° 0 

Actual increase in gross profit. 12.5% 

Factors Other than Costs Influencing Sales Policy 

After due consideration has been given to the fore¬ 
going references respecting the effect of costs upon selling 
prices, and the consequent influence on sales policies, there 
remain other factors which enter into the formulating of 
a sales policy. The following are of chief importance; 
they do not, however, cover all of the factors which 
usually exist: 

1. Status of stocks on hand: 

Stocks of raw materials. 

Stocks of finished products. 

2. Conditions of the market. 

3. Effect of restricted competition. 

Status of Stocks on Hand 

Theoretically, stocks of raw materials and finished 
product should be absolutely current for meeting the 
demands of customers. Conditions, more or less ungov¬ 
ernable, may arise, however, which prevent the realiza¬ 
tion in practice of an apparent theoretical certainty. For 
example, seasonal products which must be manufactured 
largely in advance of the season’s requirements may be 
seriously overstocked, as a result of unfavorable varia¬ 
tion of the season. The effect of such a condition would 
be principally visited upon the stock of finished goods, 
but raw materials also may be affected. In either event, 
relief would be sought through a sales policy whose object 
would be to realize the value of the stocks to the best 
possible advantage. 





MARKETING THE PRODUCT 


89 


Conditions of the Market 

Market conditions naturally affect a sales policy to a 
wider extent than any other business condition. The 
demand for new products is constantly changing, and 
variations are constantly occurring in the demand for 
standard product. It may confidently be stated that these 
two conditions exist in all markets, the essential differ¬ 
ence between the two being that a demand for a new 
product may be directly created by sales organizations, 
while variations in the demand for standard product are 
usually attributable to commercial conditions which are 
more or less ungovernable. 

Markets for new products have been more often 
developed by the production of by-products from scrap 
and waste materials than from any other source. Similarly, 
a market has often been developed for a new product, 
manufactured from an overstock of raw materials, or raw 
materials which have become inactive or obsolete for the 
purposes for which they were originally purchased. 
Where either of these conditions are applicable, they 
influence the policy of an alert sales organization. 

Effect of Restricted Competition 

Competition is apt to be confined or controlled when 
a product is manufactured under a secret process, or 
under the protection of a patent. A sales organization 
may direct the marketing of such a product, or the market¬ 
ing may rest entirely with the management. In either 
case the selling policy will depend upon the decision 
arrived at respecting the following: 

1. Is full advantage to be taken of the control of com¬ 
petition, by maintaining a high scale of gross profit 
from the product—as a monopoly—even though 


90 


PROFITABLE MANAGEMENT 


such a scale of profit reduced the demand for the 
product ? 

2. Or shall the scale of gross profit be reduced for 
the purpose of stimulating the demand, thereby 
bringing about a larger amount of gross profit 
which should naturally result from a larger volume 
of sales, although the gross profit from the unit 
would be smaller ? 

In this connection the possibilities for increasing the 
sales are not always limited to an enlargement of the 
market for the finished product. The question often 
arises as to the wisdom of providing a more extensive 
field for the use of controlled raw material, by reducing 
its price to the point at which it may be profitably used 
for purposes other than those for which it was originally 
intended. Here again a lower unit profit would be made, 
but a larger total profit would be realized from the 
increased volume of sales. 

All of the foregoing possibilities for increasing the 
sales, and the attending advantages therefrom, are depend¬ 
ent upon a correct knowledge of market conditions. 


CHAPTER X 


OPERATING INVENTORIES 

Importance of Accurate Inventories 

The subjects discussed in the preceding chapters are 
more or less distinctly connected with control of produc¬ 
tion and its cost. To this extent they bear directly upon 
profitable management. 

The subjects discussed in the present chapter relate 
to profits, but in a somewhat different manner. In the 
case of an operating inventory, profit is affected by the 
difference between actual cost and a depreciated valuation 
brought about by conditions—internal or external—which 
have no physical connection with production. In the case 
of widely fluctuating raw material prices, profit is often 
affected by a purely speculative feature as distinguished 
from the regular operating features of the business. 

Some of the matters discussed in the chapter, if not 
all, are applicable to every manufacturing business. 

The importance of accurate inventories is, of course, 
commonly understood, but the manner in which financial 
statements are affected by inaccurate inventories is not 
always fully considered. By reason of the fact that the 
ending inventory for a given period must also be the 
beginning inventory for the ensuing period, it necessarily 
follows that inaccuracies applicable to the first period 
affect the results for that period and also the results for 
the ensuing period. 

Inaccuracies—Common Sources of Error 

Inaccuracies in operating inventories are usually 
brought about by errors occurring in connection with: 

9i 


92 


PROFITABLE MANAGEMENT 


1. Quantities. 

2. Pricing the items. 

3. Computing the values. 

In each case the possibility of errors may be consider¬ 
ably reduced by adopting the use of the following precau¬ 
tions : 

1. Errors in Quantities 

If a properly planned procedure for taking an inven¬ 
tory is arranged in advance, and each participating em¬ 
ployee is duly informed in advance, scattered stocks will 
be gathered to their respective classifications and placed 
in a position which will facilitate their description, count, 
weight, or measurement. 

Inventory tests, for comparing perpetual and physical 
inventories, should have been made during the fiscal 
period and in a manner which would—at some particular 
time—cover each classification of the inventory. When 
this has been done, differences in quantities shown by a 
physical inventory would ordinarily arise as the result of 
defective procedure in taking the inventory. 

2. Pricing the Items 

The following particular considerations apply to the 
pricing of an operating inventory: 

(a) Cost or market whichever is the lower. 

(b) Conservatism in pricing items which—though 
capable of current use—may have undergone a 
greater or lesser degree of deterioration. 

(c) Conservatism in pricing items which may be more 

or less useless for current product, or which may 
be absolutely obsolete. These considerations apply 
to the following extent: 

(a) Pricing at Cost or Market Whichever Is the 
Lower. The underlying principle as to pricing at cost 


OPERATING INVENTORIES 


93 


or at market is that of reproduction or replacement values. 
The question of pricing an inventory at market value 
because that value happens to be below the cost value at 
the close of the period for which the inventory is taken, 
is not absolutely determined by the mere fact that the 
difference in values exists. The market should be free 
from artificial conditions, such as speculative features 
which exert only a temporary influence upon prices. The 
test of sound policy would be: “Does the market price 
(lower than cost) represent the probable value of the 
inventory when it is required for use?” When a reason¬ 
able doubt exists, it is commonly deemed to be good policy 
to assign the lower value to the inventory, in order that 
the asset value may not be inflated. 

(b) and (c) Conservatism in Pricing Stocks of 
Doubtful Value. The correct course to be followed in 
the case of stocks of doubtful value is undoubtedly the 
writing down of values to the point which may fairly rep¬ 
resent actual value. 

If an inventory is not classified in a manner that par¬ 
ticularizes stocks which have undergone deterioration, or 
which lack current usability, the management is unable to 
deal effectively with the subject of valuation, or with 
the equally important subject of disposing of the stocks. 
Efficient use of the capital represented by such stocks 
most certainly requires its reclamation and transfer to 
other channels, in which it may be urgently required. 

3. Computing the Values 

Undetected errors in computations are absolutely inex¬ 
cusable. Infallibility cannot be claimed for an individual, 
but if proper precautions are taken to verify the compu¬ 
tations made by an individual, errors will be detected 
before entry of the inventory is made upon the accounts. 


94 


PROFITABLE MANAGEMENT 


A satisfactory check upon computations may be made 
by having two total columns upon each inventory sheet, 
the extreme column to the right being perforated. Com¬ 
putations are first made by a clerk who uses the perforated 
column. As each sheet is completed, the column is de¬ 
tached from the sheet, the sheet being then used for 
computations made by another clerk. Upon the com¬ 
pletion of each sheet, the result (extensions and additions) 
are compared. The check has the merit of being of an 
absolutely independent character. 

Methods for Valuing Inventories at the End of a 
Fiscal Period 

The inventory of merchandise is probably the most 
important asset to appear upon a financial statement; 
hence the vital importance of avoiding inaccuracies as 
to quantities and cost, and using valuations which are 
properly conservative. Several methods for arriving at 
a valuation are used, those principally employed being as 
follows: 

Application of “Cost or Market” Method. The 
method of cost or market, whichever is the lower—the 
most generally accepted method—has been previously 
referred to. It is based on the supposition that the stocks 
on hand are those most recently acquired. For instance, 
let the following be assumed for a given classification: 

Inventory at December 31: 

100,000 units, market value (per unit $1.55). $155,000.00 

Purchases: 

July. 40,000 units, cost value $64,000.00 per unit 1.60 

September.. 150,000 “ “ “ 231,000.00 “ “ 1.54 

October.... 50,000 “ “ “ 80,000.00 “ u 1.60 

November.. 50,000 “ “ “ 77,500.00 “ u 1.55 


Totals. .. 290,000 units, cost value $452,500.00 
Used.... 190,000 “ * “ 295,000.00 


On hand. 100,000 units, cost value $157, soo. 00 









OPERATING INVENTORIES 


95 


The quantity used (190,000 units) would be deemed 
to be the units purchased in July and September, leaving 
the purchases in October and November as the stock on 
hand. As a matter of fact, the various purchases— 
assumed to be the same class of stock—would probably 
not be separated in the storeroom, so that the more 
recent purchases might be the first to be used; neverthe¬ 
less they would be deemed to be the stock on hand, the 
cost value being $2,500 in excess of the market value. 
It is, of course, to be understood that in comparing cost 
and market values, only that part of the cost value is 
taken which corresponds to the conditions of the market 
quotations. Any costs incurred which do not enter into 
the market price would not be included in the cost price 
when cost and market values are compared. Charges for 
landing the stock in warehouse are examples of such 
costs. 

Averaging the Cost of Finished Product. In 
businesses where the costs of manufacture are liable to 
frequent fluctuations, owing to fluctuations in the price 
of raw materials (as in the case of articles manufactured 
from lumber, for instance), an inventory of finished prod¬ 
uct may be valued on the basis of the following formula: 

Total cost of total production of the in- Average cost to be 
ventoried product during the fiscal period used for valuing the 

----- units of similar product 

Units of the product manufactured dur- contained in the inven- 
ing the period tory 

If the inventory covers a quantity in excess of the 
quantity manufactured during the fiscal period, the excess 
would be valued at the average of the previous fiscal 
period. 

An averaging method is often used for establishing 
a running valuation for raw material inventories, the 



96 


PROFITABLE MANAGEMENT 


averaging being done monthly. This method will be 
understood from the following formula: 


Stock on hand at beginning 

of month, cost. $ . Average unit cost, 

Purchased during the to be multiplied 

month, cost . by the units of 

- material used dur- 

Total Cost. $ . ing the month, 

-—- giving the average 

Quantity on hand at begin- = cost of materials 

ning of month, units. used, to be credited 

Quantity purchased during to the material 

the month, units. account. 


Total Quantity. 

Other methods are employed to meet the unusual 
requirements of exceptional business conditions. The 
methods described above, however, are the ones ordinarily 
used. 

Fluctuating Costs of Materials 

The production costs of products manufactured from 
raw materials which frequently fluctuate in price will, of 
course, certainly fluctuate to the extent of the difference 
in the price paid for the raw materials consumed. If 
standards of material costs are set up, the variations 
caused by price fluctuations will be definitely shown when 
standard and actual costs are compared, but only to the 
extent of the varying prices actually paid. For instance, 
if the market price of a raw material advanced during a 
current cost period, but purchases at the advanced price 
were not made during the period, a comparison of cur¬ 
rent costs with standard or previous costs would not 
account for the advance in the price of raw material 
which took place during the current period. On the 
other hand, while the costs are not affected in such a case, 
the profits very often are affected, because the selling 











OPERATING INVENTORIES 


97 


price of the finished product may be increased by the 
amount of the additional material cost which would have 
increased the cost of the finished product, if purchased 
at the increased market price. 

The profits from industries which consume large 
quantities of copper, lead, zinc, and other metals—metal¬ 
working plants; or which consume large quantities of 
cotton or wool—textile industries; are often largely 
attributable to fluctuations in the price of raw materials. 
In such cases the profits are properly divisible between 
the two factors which have produced them: 

1. Profits from regular operations. 

2. Profits from the speculative feature—fluctuations in 

the price of raw materials. 

The effect of the speculative feature, resulting from 
clever purchasing, is illustrated by the following condi¬ 
tions assumed to apply to a textile industry: 

Cotton : 

On hand at December 31, 1922, and purchased under contract 
during January, 1923: 2,500,000 lbs. at 12 cents per lb. 

As from January 1, 1923, the market price of cotton was ad¬ 
vanced to 13 cents per lb., the advance being maintained 
throughout the month. 

As from January 1, 1923, the selling price of the finished prod¬ 
uct was advanced to exactly cover the advance in the price 
of the cotton used for the product. 

The unit selling prices and unit costs of the finished 


product were: 

Unit selling prices. 

Unit costs: 

Cotton . 

Other costs. 


$3-6o 

$1.20 

1.12 

$ 3-70 

Factory cost. 

Other expense. 

.$ 2.34 

. 36 


$2.32 

•35 


Total cost. 


$2.70 


$2.67 

Net profit.. 


$ .90 


$1.03 

















g8 


PROFITABLE MANAGEMENT 


The sales in January are assumed to have been 200,000 
units. 

The foregoing details show the net profits for Janu¬ 
ary to have been (200,000 units X $1.03) $206,000, 
accounted for as follows from the comparative details 
shown: 

Net profit from regular operations of the business, 200,000 

units at 93 cents....$186,000 

Increase of net profit due to advance in market price of 
cotton, added to selling price of finished product: 1 
cent per lb. on (200,000 units x 10 lbs.) 2,000,000 lbs... 20,000 

$206,000 

In this case, 9.7 per cent of the total net profit results 
from the judicious buying of the raw material, a contract 
price of 12 cents per pound being in force at the time 
the market price is 13 cents per pound. A financial state¬ 
ment exhibiting the above-stated transactions for Janu¬ 
ary, 1923, and comparison with the prior period, would 
obviously fail in its purpose if the net profit from regular 
operations and from the replacement cost of raw material 
are not separately accounted for. 

It is a question for careful consideration in any manu¬ 
facturing business requiring raw materials which fre¬ 
quently fluctuate in price, as to whether or not it is 
advisable to price the used raw materials at the market 
price (cost of replacement) which prevails at the time 
the materials are put into operations. This course would 
have the advantage of placing the operations of the busi¬ 
ness upon an equitable basis of competition with plants 
using raw materials purchased at current market rates. 
The difference between actual cost and replacement cost 
is not a gain or loss from manufacturing operations; it is 
generally a speculative result attributable solely to pur¬ 
chasing operations. 






OPERATING INVENTORIES 


99 


If the course were followed, purchases would be 
charged into the stores at actual cost, and credited to the 
stores at replacement cost when withdrawn for use, the 
stores account being adjusted for the difference. The 
differences would be carried to a special account, which 
would exhibit the net amount for inclusion upon a finan¬ 
cial statement. The adjustments of the stores accounts 
would always show the inventory at actual cost. 


CHAPTER XI 


MERCANTILE BUSINESS 

Cost Accounting Principles and Mercantile Business 

Business methods for mercantile enterprises have 
undergone a degree of intensification probably more acute 
than with manufacturing enterprises. While a strictly 
mercantile business is practically limited to purchasing 
commodities for resale, it is nevertheless just as necessary 
to ascertain departmental costs and profit as it is to ascer¬ 
tain the cost and profit in connection with each manu¬ 
factured product of a factory. 

As shown in the present chapter, “departmentization” 
is the structural form for developing the methods of 
accounting for mercantile businesses, the governing princi¬ 
ples being identical with the principles which govern the 
production costs of a factory. 

The principles which underlie cost accounting, or 
accounting for costs, are precisely the same for any class 
of business—manufacturing, wholesale, jobbing, retail, 
financial, or any of the professions. The only difference 
is as to the amount of detail which may be required to 
arrive at the costs in each case. It is just as important 
that the management of a mercantile business should know 
the departmental results—costs, profits, losses—of the 
business, as it is for the management of a manufacturing 
business to know the costs of each operation and depart¬ 
ment of a factory and the profits or losses from each 
class of product manufactured. 

The first important development for refining what are 
now considered as primitive cost accounting methods 
divided the factory into operating departments and classi- 

ioo 

€ 

L * t 

V v 



MERCANTILE BUSINESS 


IOI 


fied the sales according to the lines of product, thus pro¬ 
viding classifications for determining the costs and profits 
for each classification. For many years similar principles 
have been applied to mercantile business. In department 
stores, for instance, the commodities are divided into 
departments, each department bearing its direct expenses 
and an equitable proportion of the general indirect ex¬ 
penses. The cost of the goods sold, plus the expenses, 
deducted from department sales, gives the net profit or 
loss from each department. 

The principles are equally applicable to other classes 
of retail businesses, such as boots and shoes, clothing, 
drugs, hardware, electrical supplies, etc. 

Departmental Divisions 

The natural departmental divisions for a retail boot 
and shoe store would be: 

1. Men’s boots—shoes 

2. Women’s boots—shoes 

3. Children’s boots—shoes 

Each department might also be subdivided in order to 
determine the results from each subdivision. For instance: 

1. Men’s boots—walking, or dress 

2. Women’s boots—walking, or dress 

The essential point would be to divide the business in 
a manner which would separately account for the results 
obtained from each distinct line purchased and sold. 

The natural departmental divisions for a retail drug 
store would principally be: 

1. Prescriptions 

2. Patent medicines 

3. Toilet articles 

4. Soda fountain 


102 


PROFITABLE MANAGEMENT 


5. Candy and confectionery 

6. Cigars 

Each department might be subdivided for the purpose 
of determining the profitableness of any particular part 
of it. 

Monthly Financial Statements Estimating an Inven¬ 
tory 

A business—be it manufacturing or mercantile—can¬ 
not be satisfactorily controlled unless fairly reliable 
monthly financial statements are possible. When the 
accounting records furnish a perpetual inventory monthly 
financial statements are usually prepared in order that 
adverse variations in costs and profits may be promptly 
shown, investigated, and corrected. 

Stock records are not always kept for mercantile 
businesses, even for businesses of considerable magni¬ 
tude. In many cases the detail work involved would im¬ 
pose an absolutely prohibitive clerical expanse. This, 
however, does not diminish the importance of monthly 
statements as a means for controlling the business. There¬ 
fore, if the conditions of the business permit a reasonably 
accurate estimate to be made of the inventory, an esti¬ 
mate should be used as a basis for monthly financial 
statements. A carefully prepared estimate would be 
fairly reliable if there existed a constant percentage rela¬ 
tion between the purchase and selling price of a com¬ 
modity, the purchase price being virtually its total cost. 
This condition exists when it is customary to change the 
selling price so as to conform to changes in the cost. 

Estimating an Inventory Illustrated 

The following details are assumed for the purpose of 
illustrating the subject: 


MERCANTILE BUSINESS 


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104 


PROFITABLE MANAGEMENT 


The foregoing illustration is in the simplest form 
possible, involving a single factor—a constant relation 
between the cost and selling values of the commodity for 
which an estimated inventory is required. An estimated 
inventory at the end of each month would enable the 
preparation of monthly financial statements, which, under 
the given conditions, should be fairly approximate. The 
estimated inventory for the last month of a fiscal year 
should approximately represent a physical inventory, 
usually taken at that time. 

It must be borne in mind that the inventory of goods 
on hand is at all times, and for all classes of business, the 
most important item to be dealt with. If a perpetual 
inventory is accurately maintained, financial statements 
of a business are possible at any time. On the other hand, 
if a perpetual inventory is not maintained and a fairly 
accurate estimate is not possible, financial statements are 
not possible until a physical inventory has been taken, 
usually once a year. Year-end statements are simply 
historical. They are of questionable value to the business 
man who wants to know how his business is going from 
month to month, or even from day to day. Modern 
records of modern business must exhibit results at short 
intervals, so that adverse tendencies may be promptly 
corrected. 

Turnover Defined 

The important question of the number of times a 
merchandise inventory is sold during a year is lost sight 
of by many business men; although the question directly 
bears upon efficiency in the use of invested capital. The 
following brief explanation and illustrations will suffice 
to show the importance of the subject: 


MERCANTILE BUSINESS 


105 


The frequency, during a given period, with which a 
manufacturer or a merchant turns over his stocks of mer¬ 
chandise is a matter which should command wider atten¬ 
tion than is generally given to it. There is, of course, 
a direct relation between frequency of turnover and profit. 
The relation is clearly shown to exist if profit is con¬ 
sidered as resulting from turnover, that is, if it is assumed 
that sales must be made before profit is possible. 

The expression “turnover of stocks” means the length 
of time which elapses between the purchase and sale of 
the stocks, or the period for which they are held as 
invested capital. Obviously the shorter that period is the 
greater the net profits will be, if we assume a constant 
rate of gross profit, irrespective of the question of fre¬ 
quency of turnover. 

Turnover Illustrated 

The following illustration brings into prominence the 
manner in which turnover may affect profits: 

Statement Arriving at Merchandise Turnover 

Business of A Business of B 


Inventory 

Cost of Sales 

Monthly 

Inventory 

Cost of 
Goods Sold 

Monthly 

Inventory 

Cost of 
Goods Sold 

January 1 

January.. . . 

. $61,910.20 

$20,117.15 

$52,127.72 

$18,716.21 

February 1 

February... 

. 52,146.02 

15 . 517 .11 

30,712.27 

24,11771 

March x 

March. 

. 79,184x2 

51,816.61 

45,116.61 

26,113.13 

April 1 

April. 

87,216.80 

35.722.27 

64,224.42 

32,410.01 

May 1 

May. 

69,410.14 

38,010.01 

76,117.80 

35,51515 

June 1 

June. 

. 114,516.76 

60,114.12 

86,427.17 

28,214.41 

July 1 

July. 

. 97.792.67 

27,76336 

75.220.04 

22,717.40 

August 1 

August. 

• 75 . 577-75 

42,198.89 

57,416.86 

19,982.28 

September 1 

September.., 

86,117.71 

40,146.64 

74 , 444-44 

30,000.00 

October 1 

October. . . . 

68,516.61 

55.32772 

71,060.60 

27,117.42 

November 1 

November.. 

57,119.91 

30,518.92 

47,297.29 

15,703.81 

December 1 

December. . . 

84,116.57 

49 , 559.80 

55,76336 

26,029.37 


I933.625.26 $466,812.60 $735,928.58 $306,636.90 




















io6 


PROFITABLE MANAGEMENT 


The stock of A is turned over six times during the 
year, as follows: $933,625.26 divided by 12 gives 

$77,802.10 as the average of stock carried during the 
year. Then, the cost of the goods sold ($466,812.60) 
divided by the average stock carried ($77,802.10) gives 
the turnover as six times during the year. 

The stock of B is turned over five times during the 
year, as follows: $735,928.58 divided by 12 gives 
$61,327.38 as the average stock carried during the year. 
Then the cost of the goods sold ($306,636.90) divided 
by the average stock carried ($61,327.38) gives the turn¬ 
over as five times during the year. 

Now, assuming A’s sales to have been $622,416.80 
and B’s sales $408,849.20, the gross profits (sales, after 
deducting the costs shown by the illustration) are the 
same percentage of sales in each case—25 per cent. 
Thus: 4 

Sales of A.$622,416.80 

Costs. 466,812.60 

Gross profit (25%).$155,604.20 

Sales of B.$408,849.20 

Costs . 306,636.90 

Gross profit (25%). 102,212.30 

Although the rate of gross profit to sales is equal in 
both cases, the ratio of gross profits to the average inven¬ 
tory investments differs, as follows: 


In the case of A, the ratio is. 200% 

In the case of B, the ratio is. 166^/3 

The ratio is in favor of A’s invested 

capital to the extent of. 33 l A 


The question of frequency of merchandise turnover 
is largely decided by the two factors: 

1. Class of commodity or product which naturally re¬ 

quires a long turnover period. 

2. Carrying an excessive stock. 













MERCANTILE BUSINESS 


107 


When the rate of turnover is decided by the first 
factor, a low rate of turnover is inevitable. Therefore, 
the greater amount of average invested capital should be 
compensated by a larger margin of gross profit. Thus, 
referring to the foregoing illustration, if B’s rate of 
turnover is decided by factor 1, his rate of gross profit 
should be about 30 per cent, if he is to realize the same 
rate of return as A upon average investment in merchan¬ 
dise inventories. This, of course, assumes that the low¬ 
est possible costs obtain in each case. 

Selling prices are mainly decided by the market; 
nevertheless the question of frequent turnover should 
not be lost sight of under any conditions. 

Value of Percentages and Comparisons 

It does not require a particularly vivid imagination to 
visualize the great disadvantage which the manager of a 
business has to contend with, if his only dependable 
guidance is the condition shown when a physical inventory 
is taken. Even though a physical inventory is taken 
quarterly—rarely the case—three months elapse before 
he knows exactly what has taken place. He does not 
require an inventory to tell him whether sales and expenses 
have increased or decreased during one period as com¬ 
pared with another, but profits cannot be determined 
without an inventory. With this understood, the impor¬ 
tance of a perpetual inventory will be quite clear. With¬ 
out it, the frequent financial statements, percentages, and 
comparisons, so essential for proper business control, 
will be impossible. 

The value of percentages and comparisons is shown 
by the following statement constructed from assumed 

figures: 


io8 


PROFITABLE MANAGEMENT 


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MERCANTILE BUSINESS 


109 


The percentages shown on the illustrated statement 
convey to a manager the following valuable information 
relating to the business done during the month of June: 

Percentages to sales—total business done: 


Cost of goods sold. 66.88% 

Selling expenses. 8.92 

General management expenses. 5.57 

Net profit.,. 18.63 


100.00% 

The gross (trading) profit, 33.12 per cent, is immedi¬ 
ately apparent. If the net profit does not meet expecta¬ 
tions, and it is not practicable to increase the selling 
prices, there are only three courses open for increasing 
the net profits: 

1. Buying to better advantage. 

2. Increasing the volume of sales without correspond¬ 

ingly increasing the expenses. 

3. Actually reducing the amount of the expenses for the 

same volume of sales. 

The percentages shown, however, enable the manage¬ 
ment to carry an analysis a step further and examine the 
results contributed by each of the five departments, thus: 

Recapitulation of Percentages to Sales 

„ „ For Departments 

For Total,-•-, 

Business A B C D E 


Cost of goods sold.. 66.88 65.00 64.00 68.00 66.00 70.00 

Selling expenses.... 8.92 10.77 9-9° 8.59 10.21 6.15 

Selling profit. 24.20 24.23 26.10 23.41 23.79 23.85 


100.00 100.00 100.00 100.00 100.00 100.00 

Departmentax Comparisons 

The following information stands out very clearly, 
with respect to each department: 



















no 


PROFITABLE MANAGEMENT 


Department A: 

Cost of goods sold. i. 88% below the average 

Selling expenses. 1.85% above “ 


Selling profit.03% “ 


Department B: 

Cost of goods sold. 2.88% below 

Selling expenses.98 % above “ 


Selling profit. 1.90% “ 


Department C: 

Cost of goods sold. 1.12% above “ 

Selling expenses.33% below “ 


Selling profit. 79 % “ 

Department D: 

Cost of goods sold.88% below “ 

Selling expenses. 1.29% above “ 


Selling profit 


.41% below “ 


Department E: 

Cost of goods sold. 3 • * 2 % above “ 

Selling expenses. 2.77% below “ 


Selling profit. 35 % “ 


If the cost of goods sold is assumed to have been the 
lowest possible cost, the points of chief interest in the 
analysis center upon the following: 

1. The larger gross profit from department A was 
practically offset by its greater selling expenses. An 
explanation of the high percentage of selling expenses 
would be in order. 

2 . The results from department B appear to point 
decisively to the wisdom of inaugurating a special policy 
for increasing the business of the department. 

3. Department C accounted for the largest volume of 
sales, with the lowest percentage of selling profit. The 
percentage of selling expenses is low. Therefore, if the 
gross profit cannot be increased, it appears to be a ques- 






















MERCANTILE BUSINESS 


in 


tion of policy as to whether the capital invested in the 
business of the department could not be more profitably 
employed in some other department. 

4. Department D appears to require careful attention 
in the matter of percentage of selling expenses. 

5. Department E shows the lowest percentage of 
gross profit which is substantially offset by the very low 
percentage of selling cost. The sales of the department 
rank second in volume. It would therefore appear to be 
policy to take advantage of the low selling cost, by 
developing the volume of sales to the utmost. 

If the conditions of a business permit a fairly accurate 
allocation of general management expenses to the depart¬ 
ments, on a basis which will fairly represent the particu¬ 
lar benefit each has received from the expenditures, the 
allocation should be made in order that net profits may be 
departmentally ascertained. 

The comparisons afforded by the illustrated statement 
are confined to the various departments and for June 
only. 

Details Required for Effective Control 

In order to provide for the possibility of absolutely 
effective management control, the records should be 
arranged to show the details required for the following 
exhibits: 

1. A daily statement of departmental sales, together with 

comparative figures for any prior period desired 
preceding day, or the corresponding date of a sim¬ 
ilar previous season. 

2. Cumulative daily totals and comparisons for each 

month. 

3. Monthly profit and loss statement, with percentages 

and comparisons. 


112 


PROFITABLE MANAGEMENT 


4. Monthly balance sheet and comparisons showing 

increase or decrease of each item in the assets and 

liabilities. 

5. Subsidiary statements monthly, usually of great value 

to the management, respecting such matters as: 

(a) Territorial sales. 

(b) Sales of individual salesmen. 

(c) Collectibility of accounts receivable. 

(d) Stocks of doubtful marketability, etc., etc. 

It may confidently be stated that no business of the 
present day can be safely conducted from year-end state¬ 
ments, very few from monthly statements, the great 
majority requiring statements which will show the daily 
trend of the business. 


APPENDIX 


SELECTED LIST OF PUBLICATIONS 


Requests come often to the author from business men 
and students for information that will enable them to 
determine the most suitable books for improving their 
knowledge of industrial management, or of cost account¬ 
ing, or of particular subdivisions of these subjects. In 
view of such requests, a list of titles may be of interest 
here. 

The list is not to be considered as in any way exhaus¬ 
tive. It was made from the author’s library, and includes 
merely the publications which he has personally found to 
be helpful and which in his opinion are valuable contri¬ 
butions to business literature. 

Any reader desiring a complete catalog of publications 
dealing with efficiency and management is referred to: 
Industrial Management, Efficiency. 

Cannons, H. G. T. Bibliography of Industrial Efficiency and 
Factory Management. E. P. Dutton & Co., 1920. 

Brinton, W. C. Graphic Methods for Presenting Facts. The 
Engineering Magazine Co., 1914. 

Cartmell, Madison. Stores and Materials Control. Ronald Press 
Co., 1922. 

Emerson, Harrington. The Twelve Principles of Efficiency. The 
Engineering Magazine Co. Rev. ed., 1917. 

Gantt, H. L. Work, Wages and Profit. The Engineering Maga¬ 
zine Co. Rev. ed., 1919. 

Gilbreth, F. B. Motion Study. D. Van Nostrand Co., 1911. 
Gowin, E. B. Developing Executive Ability. Ronald Press Co., 

igig \ 

Kent, William. Investigating an Industry. John Wiley & Sons, 
Inc., 1914. 

Knoeppel, C. E. Installing Efficiency Methods. The Engineering 
Magazine Co., 1915. 

113 


APPENDIX 


114 

Lichtner, W. O. Time Study and Job Analysis. Ronald Press 
Co., 1921. 

Parkhurst, F. A. Applied Methods of Scientific Management. 
John Wiley & Sons, Inc., 1917. 

Radford, George S. The Control of Quality in Manufacturing. 
Ronald Press Co., 1922. 

Rindsfoos, C. S. Purchasing. McGraw-Hill Book Co., Inc., 1915. 

Taylor, F. W. Principles of Scientific Management. Harper 
and Bros. Rev. ed., 1916. 

Thompson, C. B. (Editor). Scientific Management. Harvard 
University Press, 1914. 

Cost Accounting 

Bassett, W. R., and Heywood, J. Production Engineering and 
Cost Keeping for Machine Shops. McGraw-Hill Book Co., 
Inc., 1922. 

Church, A. H. Proper Distribution of Expense Burden. The 
Engineering Magazine Co. New ed., 1921. 

- Production Factors in Cost Accounting and Works Manage¬ 
ment. The Engineering Magazine Co. New ed., 1919. 

Gillette, H. P. Handbook of Cost Data for Contractors and 
Engineers. Myron C. Clark Publishing Co., 1910. 

- and Dana, R. T. Cost Keeping and Management Engi¬ 
neering. Myron C. Clark Publishing Co., 1909. 

Harrison, G. C. Cost Accounting to Aid Production. The Engi¬ 
neering Magazine Co., 1921. 

Jordan, J. P., and Harris, G. L. Cost Accounting Principles and 
Practice. Ronald Press Co., 1920. 

Kent, W. Bookkeeping and Cost Accounting for Factories. John 
Wiley & Sons, Inc., 1918. 

McKinsey, J. O. Budgetary Control. Ronald Press Co., 1922. 

Nicholson, J. L., and Rohrbach, J. F. D. Cost Accounting. 
Ronald Press Co., 1919. 

Scovell, C. H. Cost Accounting and Burden Application. D 
Appleton & Co., 1916. 




INDEX 


B 

Budget, 22-33 
co-ordination of, 3 l 
procedure, 22 
production, 30 
purchasing, 28 
sales, 24-28 
sales expense, 28 

C 

Capital, invested, 
conservation of, 34-38 
Classifications, cost, 42, 82 
Clerical work, 

standardization of, 67 
Competition, 20 
control of, 89 
Control, 

cost as basis of, 7 
methods of, 7 
records for, hi 
C o-ordination, 10 
Cost accounting, 
classifications, 42, 82 
factors, 85 
functions, 40 

mercantile business, 100-112 
results of, 45 
systems, 41 
terminology, 81 
uniform, 81-86 
Cost or market, 92, 94 


Costs, 

accurate vs. inaccurate, 48, 84 
basis of control, 7 
foremen and, 78 
information, value of, 50 
knowledge of, 4 
production, 

relation to production con¬ 
trol, 39 

relation to purchasing, 55 
relation to sales, 55 
reduction by standardization, 
64 

sales, 87 

standard vs. actual, 65 
standardization of, 63 

D 

Departmental divisions, 
mercantile business, 101 
Discounts, losses in, 38 

E 

Errors, costs, 84 
Executives, 
chief, 12 
departments, 12 
responsibilities, 8 

F 

Failures, causes, 3 
Financial statements, 
mercantile business, 102, in 



INDEX 


116 

Finished parts stores, 
unproductive, 35 
Finished product, 
averaging cost of, 95 
unproductive, 35 
Forecasting, 
sales budget, 25 
Foremen, 
as instructors, 76 
cost reduction and, 78 
functions of, 77 
training of, 77 
Freight rates, 
supervision of, 38 
Functionalization, 16 

I 

Insurance, 
excessive, 37 
Inventories, 

cost or market, 92, 94 
errors in, 91 
fluctuating costs of materials, 
96 

mercantile business, 102-107 
operating, 91-99 
perpetual, 36 
sales and, 88 
turnover, 104 
unproductive, 34 
valuation, 92-99 

L 

Labor, 
control, 69 
foremen, 76 
piece rate systems, 71 
suggestion system, 73 
training of, 75 


Labor— ( Continued ) 
turnover, 73 
wage payments, 70 
Loyalty, 8 

M 

Market analysis, 18 
Marketing, 87-90 
Markets, development of, 89 
Mercantile business, 
cost accounting, 100-112 
departmental divisions, 101 
financial statements, monthly, 
102 

inventories, 102-107 
profit and loss, 107 
records essential for, ill 

O 

Organization, 
control, 6 
co-ordination, 10 
departmental, 10 
functionalization, 16 
personnel, 8 

P 

Personnel, 8, 14 
Piece rate systems, 71 
Planning department, 
function of, 59 
operation of, 60 
results of, 61 
Production, 
standardization of, 62 
Production budget, 3 o 
Production control, 
factors in, 40 

relation to production costs, 
39 


INDEX 


n 7 


Profit and loss, 107 
Purchasing budget, 28 
Purchasing department, 
control of, 55 

Q 

Quality, 
control, 57 

foreman maintains, 79 

R 

Raw materials, 
fluctuating costs of, 96 
Research, 18 

S 

Sales budget, 24-28 
Sales costs, 87 
Sales department, 
control of, 55 
Sales expense budget, 28 
Sales policy, 87 


Scrap material, 
accounting for, 53 
control of, 51 
losses in, 37 

Standardization, 
clerical work, 67 
costs, 63 
functions of, 62 
objects of, 67 
production, 62 

Suggestion systems, 73 

T 

Trade associations, 
research by, 19 

Turnover, 

inventory, 104 
labor, 73 

Training of employees, 75 

W 

Wages, 70 

Waste material, control of, 51 


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